(FORTUNE Magazine) – Beyond the wrangling in Washington over how to parse the sentences in the new telecom bill lies a juicier question: What happens to cozy competitors when anyone with a digital impulse can suddenly crash into a market?

Check out Chile, unquestionably the wildest telecom market in the world. Last year all restrictions on entry into the long-distance business were removed at a stroke. The result: what BellSouth's Chilean manager calls "this awful, stupid competition" that squashed prices 99%. The phone wars in the U.S. look like a lawn party by comparison.

Want in? In Chile, it's simple: Just rent space on the networks of Chile's two newly privatized telephone companies (or build your own), and you're in business. Now get ready for competing in hyperdrive. Here, callers can switch phone companies on a call-by-call basis simply by dialing a three-digit prefix. The phone companies are bombarding the country with ads touting prices, so callers can clip and save on the fly.

More than half a dozen Chilean companies have jumped into the fray, along with three Baby Bells: BellSouth, which was already a cellular phone provider in Chile; SBC (a.k.a. Southwestern Bell), which spent more than $300 million to buy a stake in VTR, a major Chilean operator; and Bell Atlantic, which made a smaller investment in Iusatel, a Mexican company.

As a result, the price of off-peak calls from Chile to the U.S. fell from $1.50 a minute in late 1994--just before competition began--to about a penny a minute early last year. Prices have eased upward a bit, but they are still around 20 cents to 25 cents a minute--the lowest in the world for international long distance.

The torrid one-upmanship has also spilled into the courts, with the phone companies spitting out lawsuits like machine-gun bullets. (Most allege unfair competition.) "The guys making money here are the lawyers and the ad agencies," says Iusatel general manager Gaston Periera, formerly of Bell Atlantic.

The Baby Bells don't want to live through anything like this in the U.S., nor is it likely they will have to: Market entry will be gradual and regulated. Still, the hot Chilean market can provide a cautionary tale to U.S. telephone companies, especially to one that hasn't entered the dance down south: AT&T. Barely more than a year ago Entel, once Chile's state-owned long-distance carrier and now private, had 100% of the market. Today its share is 40%.

--Andrew Kupfer