Re: Brazil and the IMF

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

Dollarization is a non-starter, for the simple reason that Brazil cannot print
dollars.  I thought Argentina had settled that fantasy once and for all.

Henry C.K. Liu

bjm@xxxxxxxxx wrote:

> Henry and Matias
>
> I would like to interject a positive note on Brazil, and other countries in
> a similar painful situation. Like most economists, you are both
> unquestioningly accepting the proposition that a current account balance is
> necessary as a long-run condition. As a result you are the forced to pose
> the question - how it can be achieved?
>
> Instead let us try to think outside the box. Allow me please, to let us just
> suppose, that Brazil, and perhaps while we are at it the rest of South and
> Central America, were to dollarize. In this case these countries would no
> longer have an exchange rate. All would use dollars. They then no longer
> have the necessity to run a current account balance, or to think that they
> must pay for their imports with their exports. This X=M condition is not an
> economic law, as we tend to unthinkingly accept.
>
> The western US was never asked to run a balanced current account in the 19th
> century. Today the question is never even raised. By dollarizing other
> countries can be like the western US.
>
> My key insight is that a current account balance is imposed, not by economic
> fundamentals, but rather by each country choosing to use its own unit of
> account as money. We are often told that money is like a language. Everyone
> now wants their kids to learn English, because it is becoming the world
> language of business. For similar reasons countries in their self interest
> should decide to use as money the asset that most other rich countries use.
> Dollarization has similar benefits to learning English, only it is much
> easier to achieve.
>
> In a branch banking system, it is of no importance whether individual
> branches, or even individual regions, have a current account balance.
> Suppose there is a region comprised primarily of economic units with
> attractive high expected return investment projects, who all wish to deficit
> spend. Fine. Let them. Individual borrowers with attractive investment
> prospects should not be penalized because they happen to live in a region
> with many other prospective defict spenders. For the system as a whole
> deficits must equal surpluses as an accounting identity.
>
> Economists would generally accept that for many well-known reasons, in the
> long run it would be desirable to work towards a single world money and a
> single world CB, with no exchange rates.(for a nice example see eg Richard
> Cooper, 1984) But on many equally well-known noneconomic grounds, a world
> bank and a world currency is a nonstarter over any foreseeable future
> period, and is probably also not desirable in the present for these same
> non-strictly economic reasons.
>
> Dollarization is a way of finessing all these difficulties, and dumping them
> into the lap of the US. If dollarization were to come about on a large
> scale, sharing of the seignourage would soon be on the Fed's agenda. I
> predict that first Canada and Mexico will dollarize, and then other
> economies of the Americas will gradually see the light and follow. The
> benefits are cumulative, since the more countries who dollarize, the more
> the necessity of maintaining external balance disappears.
>
> In the future I predict the world will look back with curiousity on this
> difficult period, when each country still used its own currency as its
> money, and in so doing forced itself into the caldron of maintaining
> external balance, implying a current account balance to preserve the
> relative value of its currency.
>
> I am now living in SA, a country with 40 percent unemployment, huge natural
> resources, and a 15 percent inflation rate due to a 35 percent depreciation
> of the Rand last year. SA is currently forced by the IMF to keep raising its
> interest rate to high double digit levels, to keep inflationary pressures at
> bay, and so be able to preserve the value of its exchange rate, which is
> already absurdly undervalued on purchasing power terms. Countries who
> unquestionally use the noninterest bearing debt their own government as
> their money are putting themselves into this painful situation, from which
> there is no attractive escape.
>
> In their own self interest countries should select as their money asset the
> asset that is used by most other rich economies with whom they would like to
> trade. Only in this way can they escape the demons of the current
> international trading system.
>
> Basil Moore
> -----Original Message-----
> From: Henry C.K. Liu [mailto:hliu@xxxxxxxxxxxxxx]
> Sent: Sunday, November 03, 2002 7:19 PM
> To: Matias Vernengo
> Cc: pkt@xxxxxxxxxxxxxxxx
> Subject: Re: Brazil and the IMF
>
> Matias,
>
> I think I did not make myself clear.  The Brazilian trade deficit is the
> direct and
> inescapable result of an emphasis on a policy of export as the engine of
> development.  I did not mean to suggest that Brazil should not encourage
> more exports
> to remove the trade deficit, but rather, under dollar hedgemny and reliance
> on FDI to
> finance export production, Brazil had no chance of achieving a trade surplus
> without
> first destroying its economy and give back all its had gained in the past
> half a
> century.  Even for China, foreign trade has produced only a meaningless
> current
> account surplus, but a real deficit in national wealth.  China of course has
> the
> advantage of an extremely low cash wage regime because of an autarkic
> socialist
> economy imposed by 5 decades of US embargo, as compared to all other
> exporting Third
> World economies.  China is actually eating the lunch of the likes of
> Brazilian
> exporters, causing global deflation with its market power.  But China is
> heading
> toward the direction of Brazil, when the time will come when its low wage
> and state
> shirking of social responsibilities such as pension and health care
> obligations, not
> to mention education can no longer to masked under the guise of reform to
> market
> economy.
>
> I agree with your three additional factors.
> I would like to read your paper if you would kindly send it.
>
> Henry
>
> Matias Vernengo wrote:
>
> > Henry:
> >
> > Although you are absolutely correct about the initial (1994-99)
> appreciation of
> > the currency, you are completely off the mark regarding the "misguided
> emphasis
> > on exports."  For two reasons, I should add.  First, there was no emphasis
> on
> > export promotion in the first Cardoso period (1994-98).  In fact, Brazil
> moved
> > from trade surpluses of 6 per cent of GDP to deficits of 3 per cent (add
> always
> > an additional deficit in invisibles to get a bigger deficit in the current
> > account). This was caused both by a surge on imports (given trade
> liberalization)
> > and lack of exports.   Second, a better export performance would have
> implied a
> > lower trade deficit, and hence less accumulation on foreign debt.  Foreign
> debt
> > (as much as domestic debt) exploded during the Cardoso years, from
> slightly above
> > 20 per cent to more than 50.  An emphasis on exports would not have been
> > misguided, quite the opposite.   Instead of your number one (emphasis on
> > exports)  let me throw some problems that should be mentioned, and that
> are more
> > relevant in my view regarding the current predicament of the Brazilian
> economy.
> >
> > (1) Excessive reliance on trade liberalization
> > (2) Same for the capital account
> > (3) Incredibly high interest rates (with emphasis on this one)
> >
> > Unilateral trade liberalization meant that Brazilian average tariffs on
> American
> > goods are lower than American tariffs on Brazilian goods.  Even if you
> believe in
> > Ricardian comparative advantage, this was an exaggeration, that generated
> > persistent trade deficits (which lead to accumulation of foreign debt) and
> > unemployment (by the way, compare with the slow process of liberalization
> in
> > China). Capital account liberalization was pushed hoping to attract FDI to
> boost
> > growth.  FDI came, but almost half was brownfield investment into
> privatized
> > sectors.  Also, the trade deficits implied an increasing need of hot
> capital
> > flows which led to the third problem, namely: high interest rates.  High
> interest
> > rates, in turn, led to an increasing burden of debt servicing, aggravating
> the
> > fiscal deficits.  High interest rates, and the agreements with the IMF
> (which
> > demanded primary fiscal surpluses) led to lower effective demand.
> Needless to
> > say unemployment has become the great problem and the biggest elector of
> Lula.
> >
> > Some of this issues are in a paper I wrote for the project on "External
> > Liberalization, Income Distribution, and Social Policy," directed by Lance
> > Taylor, called "Belindia Goes to Washington: Brazil After the Reforms,"
> and will
> > be available soon at the Center for Economic Policy Analysis website
> > (http://www.newschool.edu/cepa/).  I can send it to you if you are
> interested.
> >
> > All the best,
> >
> > Matias
> >
> > "Henry C.K. Liu" wrote:
> >
> > > The real fundamental problem with Brazil was two fold: 1) A misguided
> > > emphasis on export and 2) a misguided monetary policy of fixed exchange
> > > rates.
> > >
> > > Both of these policy errors trapped Brazil into being a victim of dollar
> > > hegemony.
> > >
> > > No version of debt resolution can save Brazil, however humane or
> ingenious.
> > >
> > > Brazil needs to adopt the State Theory of Money and free up sovereign
> credit
> > > for the revitalization and development of its domestic economy.  This
> can
> > > only be done with exchange control.  Tell the IMF to go home and impose
> > > strict control on imports payable in foreign currencies.  Require all
> > > Brazilian exports to be payable in Brazilian real.
> > >
> > > See:
> > > http://www.atimes.com/atimes/China/DG23Ad04.html
> > >
> > > see:
> > > Crippling debt and bankrupt solutions
> > > By Henry C K Liu
> > > http://www.atimes.com/atimes/Global_Economy/DI28Dj01.html
> > >
> > > In Brazil, the government was forced to allow a short two-day period of
> 9
> > > percent devaluation of its peg before it threw in the towel on January
> 15,
> > > 1999, and suspended foreign-exchange control and abandoned the peg to
> allow
> > > the Brazilian real to free-float. Seven years earlier, in 1992, even the
> > > mighty British Treasury had to throw in the towel in its failed defense
> of
> > > the pound sterling against the onslaught of the bet against the currency
> > > staying in the Exchange Rate Mechanism from George Soros's hedge fund.
> > >
> > > During the first two days of the Brazilian crisis, the government tried
> to do
> > > a stock purchase, copying Hong Kong's example of "market incursion" in
> August
> > > 1998. But it was a non-starter. Hong Kong had to use US$18 billion in
> two
> > > days to foil the manipulation of its stock and futures markets on August
> 29,
> > > 1998. Brazil had only US$30 billion reserve left by January 14, 1999,
> > > compared with Hong Kong's US$100 billion, and the Brazilian market was
> bigger
> > > than Hong Kong's. So the government decided that it was futile even to
> try,
> > > after some faked moves failed to spook unimpressed speculators.
> > >
> > > For many years, IMF experts had touted the myth of the indispensability
> of
> > > fixed exchange rates for small economies heavily dependent on external
> trade,
> > > such as Hong Kong, or large free-trade economies facing high inflation,
> such
> > > as Brazil, in the context of an international finance architecture set
> up by
> > > the Bretton Woods regime. The inertia of the status quo and the lack of
> hard
> > > data on the uncertain effects of de-pegging had permitted this myth to
> assume
> > > the characteristics of indisputable truth, even though the Bretton Woods
> > > fixed-exchange-rate regime had been abandoned since 1991 and
> deregulation of
> > > global financial markets had totally changed the rules of the
> international
> > > finance game.
> > >
> > > Brazil pegged its currency to the US dollar as a way of fighting chronic
> and
> > > severe inflation. When the Real Plan was introduced in 1994, inflation
> was
> > > 3,000 percent annually.
> > >
> > > The overvalued Brazilian currency peg inflicted much pain on the
> economy,
> > > first in the export sector and subsequently spreading throughout the
> entire
> > > economy. Both industry and labor had wanted for a long time a
> lower-valued
> > > currency (the real) to relieve Brazil from a high (70 percent) interest
> rate
> > > and to revive an export sector saddled with heavy foreign debt, even if
> the
> > > pre-devaluation low inflation of 3 percent was expected to rise as a
> result.
> > >
> > > The crisis in Brazil was triggered by a moratorium on state debt
> payments
> > > imposed by the large and wealthy state of Minas Gerais on January 12,
> 1999.
> > > On January 13, Brazil devalued the real by 9 percent, having seen its
> foreign
> > > reserves drop by more than half in the previous five months to US$31
> billion.
> > > A drain of $1.8 billion from the Brazilian central bank was recorded the
> > > following day. At that rate, Brazil only had 15 days to go before it
> would
> > > run out of reserves.
> > >
> > > On the morning of January 15, to stop the financial hemorrhage, Brazil
> lifted
> > > exchange-rate control entirely and allowed the real to float freely in
> the
> > > foreign-exchange markets without central-bank intervention. Within
> minutes,
> > > the real fell to 1.60 to the dollar from its previous 1.32, but by day's
> end
> > > settled around 1.43. By the end of the trading day on January 15, Brazil
> had
> > > managed to halt the flight of the dollar, with the real down 10.4
> percent for
> > > the day and 18 percent from the pegged rate, even though the market had
> > > estimated the real to be overvalued by 30 percent.
> > >
> > > In the long run, a gradual float to the estimated market value was
> considered
> > > reasonable. But the overvalued currency was allowed to linger too long
> and
> > > did too much structural damage to the economy, which continued on a
> downward
> > > slide. The real is now trading around 3.6 to a dollar.
> > >
> > > Still, with a free-floating currency, Brazil's short-term interest rate
> fell
> > > from 71.65 percent to 36.11 percent in one day and the stock market
> jumped 34
> > > percent on January 15, 1999 from its previous low, with lifting effects
> > > worldwide on other markets. The Dow Jones Industrial Average (DJIA) rose
> > > 219.62 points, or 2.4 percent, to 9,340.55 on that day. US Treasuries
> dropped
> > > sharply, reversing the flight to quality, pushing yield on 30-year bonds
> up
> > > to 5.12 percent from 5.05 percent. By 7pm on January 15, only $173
> million
> > > had left Brazil's foreign-reserves coffer.
> > >
> > > In 1999, Brazil had to face a budget deficit and a $270 billion foreign
> debt.
> > > But its self-imposed penalty of an overvalued peg was removed, gaining
> > > improved conditions for export and stimulative effects for domestic
> demand.
> > > However, IMF conditionalities forced Brazil to adopt austerity budgetary
> > > measures and privatization that prevented domestic economic development.
> > >
> > > With Brazil's currency free-floating, it was obvious that Argentina's
> > > currency board regime could not hold. Argentina tried dollarization
> briefly,
> > > but the combined penalty of high interest rates, asset deflation,
> reduced
> > > exports, trade deficits and high unemployment finally pushed the country
> off
> > > the cliff in 2001, defaulting on its $95 billion sovereign debt.
> Argentina is
> > > living proof of the myth of dollarization as the path to economic
> security.
> > > http://www.atimes.com/atimes/China/DJ16Ad04.html
> > >
> > > "James K. Galbraith" wrote:
> > >
> > > > PKT friends --
> > > >
> > > > I have just published an essay on Brazil, the IMF, and larger monetary
> > > > issues through the Levy Institute;  it is available at
> > > > http://www.levy.org/docs/pn/02-2.html for those who may have an
> interest.
> > > >
> > > > With regards.
> > > >
> > > > James Galbraith
> > > >
> > > > *****
> > > > Professor James K. Galbraith
> > > > Lloyd M. Bentsen, Jr. Chair in Government/Business Relations
> > > > LBJ School of Public Affairs
> > > > The University of Texas at Austin
> > > > Austin TX 78713-8925
> > > >
> > > > See the UTIP web-site at http://utip.gov.utexas.edu
> > > > See the ECAAR web-site at http://www.ecaar.org
> > > > See the Levy web-site at http://www.levy.org