(FORTUNE Magazine) – Will Latin America be the next domino to fall in the great emerging market collapse? That's no idle question, because more than a fifth of U.S. exports, or some $70.8 billion, go to Latin America. If the region goes, the U.S. will feel the pain.

For the answer, watch Brazil. Brazil generates a third of its region's economic output and is also a major consumer of its exports. Brazil's GDP is twice the size of Russia's and two-thirds larger than Southeast Asia's and Hong Kong's put together. Lured by a hot economy, American companies have stampeded into the region. In 1998, Brazil expects to receive $12 billion in American direct investment, a 50% increase over last year, from companies like Ford, GM, Coca-Cola, and Xerox.

Sounds good, but lately Brazil's economy has been slowing. And if, as some analysts expect, it falls into recession, so will the rest of Latin America. What are the chances of Brazil's avoiding that fate? They don't look good.

The collapse of the Russian ruble and concerns about China's currency have put enormous pressure on the real, which is overvalued by as much as 20%. Brazilian President Fernando Henrique Cardoso has raised interest rates and spent foreign reserves in his determination to defend the currency. If the real sinks anyway, Argentina, Mexico, and other Latin states are likely to devalue--as Colombia already has--and also raise interest rates to keep their currencies from falling too far. In Brazil, where short-term rates already stand at about 20% and economic growth is now just 1.5%, the result would surely be recession. Argentina, which does 30% of its trade with Brazil, would lose steam. So, in turn, would next-door Chile and the rest of South America.

The news gets worse. Cardoso's political fortunes depend on his ability to forestall a devaluation. A free-market reformer who is running for reelection on Oct. 4, Cardoso is celebrated as the man who beat hyperinflation. Brazilians appreciate the achievement: According to a recent poll in the newspaper O Estado de Sao Paulo, he leads his opponent, leftist Luis Lula Da Silva, 46% to 22%. If Cardoso were forced to devalue under pressure, however, the collapse in confidence and subsequent economic instability could cost him the election. Given Da Silva's opposition to privatization and open markets, that would vaporize investor confidence in Brazil and set back economic reform for years.

Latin America cannot afford to let that happen. With falling commodities prices--and much of Argentina, Chile, and Mexico already privatized--foreign investment is critical to economic growth. It is worth noting that when Thailand blew up in 1997, even patient companies like General Motors scaled back their investments.

If Cardoso wins, there is sharp debate over whether he should impose a "controlled devaluation" of 5% or less. Those who favor such a move argue that a modest devaluation is better than keeping interest rates high, as long as it is part of a fiscal-reform program that also cleans up murky banking practices and cuts public spending. The government deficit is running at 7% of GDP, the highest in the region. The counterargument is that any devaluation will wreck investor confidence. One thing is certain: If Brazil fails to act decisively, it--and the rest of Latin America--will continue to pay for other countries' economic troubles. And that would surely send further tremors throughout U.S. markets.

--Edward A. Robinson