Brazil: Model Economy or Model Deadbeat?

Trade Alert ^ | 8/15/02 | Alan Tonelson

[madeinchina]

If Brazil is such a well-run economy, how come it's piled up as much as $290 billion in public debt? That's a question no one in the globalization-happy economic establishment wants to even ask, much less answer. Yet the determination of Washington, the International Monetary Fund, and all the world's other economic power centers to duck the main issues raised by Brazil's woes can only weaken, not strengthen, the global economy's foundations.

The strongest praise for Brazil came literally when the checks were being written to forestall the country's bankruptcy. Said IMF chief Horst Kohler, "Brazil is on a solid long-term policy trend which strongly deserves the support of the international community." According to U.S. Treasury Secretary Paul O'Neill, a longtime bailout skeptic, "The economic team in Brazil has done a remarkable job."

This praise for Brazil has several related purposes. It seeks to explain why Brazil is being helped but not neighboring Argentina - widely seen as the bad boy of the world economy. And it seeks to reduce moral hazard - to convince other third world countries that international agencies and rich-country governments are not going to rescue just any old deadbeat state. Only debtors trying to do the right thing, and whose problems are allegedly beyond their control, will get aid. Otherwise, why would third world governments use resources wisely, instead of embarking on wild shopping sprees?

Brazil has done some things right economically in recent years. Recognizing its need for capital, it has opened to foreign investment. Unlike Argentina, Brazil's floating exchange-rate policy kept its international obligations manageable until recently. (Only about a fifth of Brazil's debt is owed to foreign creditors.) It has improved tax collection modestly and reduced government spending. And the country has tamed hyperinflation.

But Brazil a model economy? Please! It created a regional trade bloc with Argentina and other neighbors, called Mercosur, that turned these countries into major markets for its goods. Then in January, 1999, in response to another financial crisis, it devalued its currency, the real, and helped throw these trade partners (especially Argentina) into deep recession - quickly undermining its own exports in the process.

Most important, however, like the roundly condemned Argentines, Brazil scored its big success in controlling inflation with a gimmick. As in Argentina, the gimmick was understandable politically. Endlessly raging inflation in a country with Brazil's huge rich-poor gap is a recipe for revolution or chaos. And like the Argentine gimmick, Brazil's helped to permit enough ordinary Brazilians to live beyond their means to preserve political stability while avoiding the kinds of social and economic reforms that would have threatened wealthy elites. But also like Argentina's gimmick, Brazil's proved unsustainable.

Where Argentina created a currency board that held prices in check by yoking the peso to the U.S. dollar, Brazil maintained stratospheric interest rates. With businesses forced to borrow at 40 percent, the Brazilian government restrained domestic demand and thus price increases. Interest rates near 20 percent also attracted considerable foreign investment in government bonds (as did exchange-rate terms that protected foreign creditors from weakness in the real). But these rates also choked the domestic economy, along with any real hope that Brazil could gradually grow out of its present debt. And the exchange-rate protection for foreigners greatly multiplied the country's future debts when the real began weakening.

Receipts from massive privatizations brought in big money, keeping Brazil's economy reasonably buoyant and its budget deficit under control. But not even tens of billions of dollars worth of such foreign direct investment could long offset anemic domestic investment, decelerating growth, economic collapse in Argentina, and growing investor nervousness about emerging markets generally.

This summer, opinion polls began revealing that left-wing populist candidates who hinted at debt cancellations were the front-runners for the October presidential vote. Such political developments shouldn't take place in a well-run economy, either, but they pushed Brazil from a sick bed to the intensive care unit. Both Brazilian and foreign creditors dumped reals, borrowing costs soared higher, maturities became shorter, growth slowed further, and a classic vicious financial cycle had begun.

The Bush administration and the IMF have structured the $30 billion bailout so as to delay most disbursements till after the election. The idea clearly is to give whoever wins strong incentives to stay on the sound economy path. But Brazil never truly went down this road, and the bailout, however disbursed, will only enable the country to keep covering up its weak fundamentals - until the next emergency strikes.

And strike it will. Now that Brazil has been all-but-officially deemed too big to fail, foreign banks will see high-interest bridge loans and rollovers as a perpetual cash cow. Movement toward a western hemisphere free trade agreement will help sustain the flow of multinational manufacturing investment into the country. After all, if Brazil still can't absorb the output, it can always be shipped to the United States - unless America's own trade-strained finances begin buckling. And the Brazilian government will continue to buy off the poor and middle class with welfare programs that remain as meager as they are unaffordable.

All the while, similar scenarios will play out with other big, fragile third-world economies. And America's short-term stakes in these ponzi schemes will grow even bigger. If only the same could be said for our ability to pay for them.

[madeinchina]

You have to wonder what it was that turned Paul O'Neil around so quickly about Brazil?

[Red Jones]

bump

[Free the USA]

Index Bump