Many developing countries experience output volatility. Sovereign wealth funds can buffer these shocks, as recent experience in Chile has shown.

Thousands of government workers marched on downtown Santiago [in November 2008], burning an effigy of Chilean Finance Minister Andres Velasco and calling him “disgusting” as a strike for higher wages paralyzed public services.

Five months later, polls show that Velasco is President Michelle Bachelet’s most popular minister. During a three-year copper boom he and central bank President Jose De Gregorio set aside $48.6 billion, more than 30 percent of the country’s gross domestic product, that he is now using for tax cuts, subsidies and cash handouts to poor families.

The Chilean peso has risen almost 10 percent against the dollar this year to become the best-performing currency among emerging markets. The country’s economy is expected to grow 0.1 percent in 2009, as the region contracts 1.5 percent, according to the International Monetary Fund… .

Velasco, 48, applied the lessons learned from decades of economic failure in Latin America—ones he said could also help the U.S. The current crisis followed “a massive regulatory failure in many advanced financial markets over the last decade or so,” Velasco said in an interview April 21 [2009] in his office overlooking the presidential palace in downtown Santiago.

“This is a movie that may be novel to some Americans, but this is a movie that people in other places of the world, Chile included, know we have seen,” said Velasco, who is scheduled to meet April 25 with Federal Reserve ChairmanBen S. Bernanke in Washington. “We know how it begins, how it unfolds and how it ends.” …

Commodity-driven swings of boom and bust have defined Latin America’s economic history for the past 100 years.

“That is a cycle that needs to be ended,” Velasco said. “We have been out to show that a Latin American country can manage properly, and not mismanage, a commodity cycle. You save in times of abundance, and you invest in lean times.”

When Velasco joined Bachelet’s new cabinet in March 2006, the price of copper had risen by more than half in 12 months to $2.25 a pound. Taxes and profits from state-owned Codelco, the world’s largest copper producer, provide about 15 percent of government revenue. Bachelet, 57, Chile’s second consecutive socialist president, came under almost immediate pressure to start spending the revenue.

Students went on strike in May of that year, demanding more money for education. More than 800,000 people protested at high schools and universities, and police with water cannons and tear gas arrested more than 1,000. Velasco reiterated his commitment to “prudent fiscal policies” as politicians from the governing coalition demanded he resign… .

In his first three years in office, Velasco posted the biggest budget surpluses since the country returned to democracy in 1990. In 2007, Chile became a net creditor for the first time since independence from Spain in 1810.

Last July [2008], copper reached a record of $4.08 a pound. By year-end, the central bank had built $23.2 billion of reserves. The government had $22.7 billion in offshore funds and about $2.8 billion in its own holdings. After Lehman Brothers Holdings Inc.’s September 15 bankruptcy sparked a global credit freeze, Velasco and De Gregorio had the equivalent of more than 30 percent of GDP available if needed to shore up Chile’s banks and defend the peso.

The price of copper plummeted 52 percent from September 30 to year-end, and Velasco dusted off his checkbook. In the first week of January, he and Bachelet unveiled a $4 billion package of tax cuts and subsidies.

“He has been vindicated,” said Luis Oganes, head of Latin American research at JPMorgan Chase & Co. in New York, who studied under Velasco… .

Velasco’s stimulus spending, including 40,000-peso ($68.41) handouts to 1.7 million poor families, has paid off politically. His approval rating almost doubled to 57 percent in March from a low of 31 percent in August… . He is now the most well-liked member of the government, second only to the president at 62 percent.

“People finally understood what was behind his ‘stinginess’ of early years,” said Sebastian Edwards, a Chilean economist at the University of California, Los Angeles. “That explains the rise in his popularity.”

Source: Excerpted from Sebastian Boyd, “Harvard Peso Doctor Vindicated as Chile Evades Slump,” bloomberg.com, April 23, 2009. Used with permission of Bloomberg L.P. © 2013. All rights reserved.

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