Re: Brazil and the IMF

[Matias Vernengo <vernengo@xxxxxxxx>]

Basil:
I agree completely with Henry, as you know.  Also, you should note that
dollarization does not eliminate the main problem of developing countries. If they
don't balance their trade account not in a single period, but over several (that
is, if they are to avoid explosive debts), they must get dollars.  In the absence
of those the adjustment will be on the level of activity, i.e. importing less.
Hence, Argentina's brutal recession.  This was in fact the pattern of the gold
standard, the mecca of pro-dollarizers.  By the way, thanks for the clarification
Henry.  I am glad we agree.  I'll send you my paper off list.
Matias


"Henry C.K. Liu" wrote:

> 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