Peru’s GDP Growth Demonstrates Less Market Intervention is More

The WealthCycles Staff

As Western investors continue to agonize over the United States’ impending “fiscal cliff” and whether Europe’s recent currency expansion and debt relief programs will save the euro, the nation of Peru, little noticed by pundits and major media outlets, is providing an example of how to do things right. Both the media and the leaders of the world’s largest economies might do well to borrow a page from Peru, which has consistently delivered GDP growth of between 6% and 9% year over year. So what is Peru doing right that the rest of the world is doing wrong?

According to a June 2012 statement by Goldman Sachs’ chief economist for Global Investment Research, Jan Hatzius, both the U.S. and EU are expected to see minimal growth for the last half of 2012 and into 2013. For the U.S. this growth is expected to be somewhere between 1.8 and 2.0 percent. When accounting for persistent losses in purchasing power of the currency GDP is measured in, the “growth” is actually contraction. For example, if price inflation in the U.S. is 4.0 percent, real GDP (as opposed to nominal) shows a 2.0 percent decline in the best case. Over the past four years, growth in U.S. output (nominal GDP) has varied from -8.9% to a high of 4.1%.

Now compare the U.S.’s feeble record to the rate of Peru’s GDP growth.

The unflattering comparison above begs the question: What is Peru doing that the U.S. isn’t—and should be—doing?

The short answer is, Peru’s leadership is adhering to consistent and disciplined monetary and fiscal policies. One example is the decision by Peru’s central bank to hold interest rates steady, as Reuters reports.

Peru's central bank held its benchmark interest rate steady at 4.25 percent for the 18th month in a row on Thursday, as inflation has retreated and the economy grows near its potential.

It is the Peruvian finance ministry’s and central bank’s steady policies that allows for planning and formation of expectations by entrepreneurs. Businesses are initiated, and hiring commences. Relatively limited government spending ensures a booming economy in Peru as capital is left in the private sector where efficient economic calculation is possible, as opposed to simply consuming capital. As a result of the relatively good decision making, the Peruvian currency, the sol, traded at its all-time high earlier this year.

On October 22, the sol reached a 15 year high against the dollar, at 2.5780. The sol has gained 17 percent in the last five years making it the best performing Latin American currency.

Not everything in Peru is blossoming, however;Julio Velarde, president of the Banco Central de Reserva del Peru, implemented policies that were aimed at weakening the sol in relation to the Federal Reserve Bank’s dollar in a fit of new-economics Keynesianism. This included raising the reserve limit on accounts held in dollars, furthering the restrictions on the sale of the Fed’s dollars, as well as increasing reserves by buying $12 billion. Just two short weeks after Velarde took those steps, the PEN (Peruvian sol) was down approximately 17%—exactly what Velarde expected, and but very detrimental to the natural balance free prices would have lent to the developing Peruvian economy. A weaker currency subsidizes exports at the expense of both imports and the Peruvian people’s savings. And as we know, savings and capital formation is the precursor to business investment, development and hiring. Despite the shortcoming, many countries take even stronger tactics in following false prophets.

Peru’s finance minister Luis Miguel Castilla, recently named Latin American Finance Minister of the Year by Emerging Markets Magazine, avoided the heavy-handed market interventions and nationalization of resources practiced by Venezuela’s Hugo Chavez. Although Castilla instituted reforms to Peru’s lucrative mining sector, he ensured it remained competitive in the world market and attractive to foreign investors.

Castilla was key in maintaining a stable economic strategy during the transition of power after the left-leaning Gana Peru won power in July 2011.
…Pablo Goldberg, head of emerging market research at HSBC, says the finance ministry played a role in ensuring the new government saw the “benefits of keeping the course” in many aspects of macroeconomic policy. “There were important concerns in the market about what could have happened and whether [Gana Peru] could have taken a different approach,” he says.

What happened in Peru is that once local and international investors realized its economy was stable with steady hands at the wheel, a strong business infrastructure began to develop as foreign trade flourished and investment funding poured in. As a result, Peru’s unemployment is low, its economy steadily growing in real terms, with wage and price structure in balance. Despite the boom, many are still saving in silver and gold coin as the history of currency losing purchasing power is no foreign affair.

In contrast to Peru’s chief banker, Ben Bernanke, chair of the Federal Reserve Bank, has lowered interest rates to near zero and shows no sign of allowing them to rise anytime soon. Rather than implementing measures to keep their dollar strong, Bernanke is working overtime to debase the dollar, increasing the rate of expansion of the currency supply. The U.S. economy remains depressed, unemployment remains high, and price inflation is already significant, and about to explode higher. In the economic turmoil of the day it is ironic that Peru’s economy, like Iceland’s, is growing, its currency is strong, and its price inflation is under control—but it’s no accident.

interesting stuff.

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