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Bye Bye Brazil

For about a decade there, Brazil was the Latin American country that got it right. Under a socialist but apparently reasonable government they kept their budgets under control, managed the population shift from farm to city, and developed some efficient export industries that brought in plenty of hard currency. The Brazilian real held its own on foreign exchange markets and inflation was, as a result, moderate.

Then it all fell apart. The US dollar spiked, commodity prices tanked, and it was discovered that a whole range of big local players were gaming the system in various ways, sparking a corruption scandal that reaches all the way to top.

Brazil’s real is now the worst performing major currency (in a world of badly-performing major currencies), its budget deficit is 8% of GDP, the interest rate on its 10-year bonds exceeds 15%, and GDP is apparently about to fall off the table.

Brazil real Aug 2015

Brazil GDP Aug 2015

There are calls for the impeachment of the president and rising speculation that the finance minister, unable to get spending cuts through the legislature, is about to quit. The latter’s departure will remove the last prop from Brazil’s investment grade credit rating, making it even harder to borrow, necessitating even bigger spending cuts, and sending the country into a stereotypical LatAm death spiral. Just in time for it to host next year’s Olympics.

A big part of the problem is the decision by major Brazilian companies like oil giant Petroleo Brasileiro to fund their rapid growth by borrowing tens of billions of US dollars. When the real was rising and dollar interest rates were low, this strategy was a double winner. But when the dollar spiked in 2014 the true cost of those loans went through the roof.

In this sense Brazil is one of the high-profile casualties of the currency war. And with the US about to raise rates while most other countries lower theirs, it’s only going to get uglier. Which means (here’s why this matters beyond Brazil itself) the big US banks and other major creditors are looking at multi-billion-dollar losses in 2016. Turns out that China has been on a lending spree in Latin America, extending more than $100 billion in credit to various state-run oil and mining companies since 2005. And whenever there’s a South-of-the-Border crisis, Citigroup, Goldman and JP Morgan are in the mix, demanding a bail-out so year-end bonuses aren’t affected. The Mexican peso crisis of 1994 was, in fact, the genesis of the Greenspan put that turned the money center banks into giant hedge funds.

So Brazil will illustrate the differences between now and then — if there are any.

41 thoughts on "Bye Bye Brazil"

  1. – Brazil is “Investment Grade” ? with rates at 15 % ?
    – Currency war ? No. US investors wanted higher yields on their fixed income and reached for brazilian bonds. But now with the REAL falling & rate rising those investors are getting hammered.

  2. – Intesrest rates at 15% ? Since A LOT OF brazilian companies borrowed in USD (think lower interest rates) A LOT OF US investors are losing LOTS of money. Those investors lended those companies money because the rates offered were higher than US rates. It’s the typical “Reach for yield”.
    – No, “other” currencies haven’t been that badly but it was the USD (+Yen) that went up against ALL other currencies (CAD, EUR, BRL, AUD, NZD, TRY, etc.). And that hurts the profit margins of US companies. And a rising USD is PRECISELY what I expected to happen. It’s THE SIGN of a thing called “DEFLATION”. (No, HYPERINFLATION is NOT anywhere on the horizon).

    1. Willy,I agree with you about deflation.Deflation is taking place partly because many companies are shutting down for lack of business.Primarily in retail,there are many,if not most,retailers who have business models & profit structures geared to cheap money & endless credit!These companies are having a hard time getting competitive against internet outfits like Amazon & E-Bay!Many will not make it!This in turn will put a big hole in the commercial real estate business!

  3. Who gives a crap about brazil???? Would somebody PLEASE help the DOW!!! Anything! I’ve lost a fortune and I’m desperate.

    1. You should care about Brazil because they have borrowed LOTS of money in USD, to US investors (pensionfunds ???) and those investors will be losing LOTS of money when/if Brazil defaults,

    2. i hate to say this, but there was a LOT of warning about this stock market being overvalued for a long time. Unless you were listening to the MSM clowns.
      Take what you have left OUT of the market and buy gold/silver.

  4. I just talked with a friend in Rio this morning. She lost her job–she did find a new one since she is bilingual, her taxes are way up, prices are way, way up and wages are stagnant. They have political corruption and crisis after crisis and crime is skyrocketing. It is just another day in paraíso.

    1. Coming soon to America, especially the higher taxes part. All those un- and underfunded government pensions and programs will need huge amounts of money to keep them from collapsing.

      1. Roddy,
        I am hoping that America can ride it out better then most of the rest of world!
        As one wit said “The USA can win the financial beauty prize by being the least ugly contestant! My own feeling is that if America financially fell off the roof of a 20 story building it would have a soft landing because it would land on the bodies of 10 or 15 other countries which preceded it off the roof!
        The American public has grown fat & lazy with unlimited credit,we can tighten our belts a long way before the average citizen feels real pain!Real economic pain will hit poorer countries which are financially marginal to begin with!
        The problems we have go beyond the economy,they are political,social & structural & cannot be fixed by events in the financial markets,…in effect the solution may lie in the reverse order of things!

        1. “The American public has grown fat & lazy with unlimited credit,”- Where did you get that idea? My credit cards all charge 12-20+%

  5. Thanks John for another great article and as usual , spot on save for one point. I have a strong suspicion the Federal Reserve is at this moment franticly searching for a way to avert a rate hike. Wall Street is irreversibly hooked on free money and ” The Street ” is now dependent upon free cash to survive without imploding. The cash must continue to flow so Companies can continue to purchase their own shares financed with zero interest loans. They created this monster and now their back is against the wall, literally.
    It makes me long for the old days when stocks were valued upon marketplace results. Now, we have a host of the ” walking dead ” Corporations , alive only because they’ve been able to borrow billions to keep alive their failing business models.
    Postkensyianism ? Don’t hold your breath.

    1. Any rate hike by the Fed will be so little and so forecasted that it won’t matter – initially – but the greater “dilemma” will be if it should capitulate and initiate another QE program. Just kick back and enjoy.

  6. This article is so ideological. For starters the statement “Under a socialist but apparently reasonable government” is SO biased. Second, the Brazilian economy has entered into a self-inflicted crisis due to the dominance of the Neoliberal group think that dominates the World today. Interest rates can be set at whatever level the central bank choses. If they decide to pay 15% they can bring it down tomorrow. A deficit level of 8% for a currency issuing government is not important (functional finance principle of Abba Lerner). The country has a trade surplus, inflation is moderate and there are plenty of effective ways of bringin it down without generating inflation and public debt. The only reason why the economy is in recession is that Mrs. Dilma Roussef has too many Neoliberals giving her dumb advice. She should fire them and hire some Postkeynesians.

      1. ” Interest rates can be set at whatever level the central bank choses. If they decide to pay 15% they can bring it down tomorrow.”

        Haha! Stuart sounds just like Ben Bernanke!!!

        The Almighty central bankers can adjust interest rates and reverse policy in 15 minutes flat! Remember that one? 😉

          1. And generals can win most battles if the have enough troops & don’t care about high casualty rates.Problems arise when the troops start to worry about these casualty rates & end up mutinying!

            Likewise Central Banks can create infinite amounts of bogus I.O.U’s which they call money,as long as they don’t care about the well being of the general populace.Problems here arise when the the public grows weary of being forced into impoverished peonage & also Mutinies,….just like the troops!

          2. All money is an IOU of the government. In fact, the difference between money and public debt is that the former pays no interest. Money supply can grow by public spending or bank credit. Taxation cancels the excess money supply and another part goes to private savings.Try to bring about a government surplus and private savings go down. People need or want to have savings. The only way that the private sector, as a whole, can have a positive net financial position is by running a public deficit or a trade surplus. Try to bring down the deficit and you will cause a recession as people see their savings do down and try to reduce their consumption. All money is “bogus” IOUs.

          3. And the fact still remains that you will destroy the middle class consumer by eliminating his ability to pay for consumer goods,either by drying up his wealth or destroying his credit line.never mind all of this Keynesian babble,the only way the financial elite can survive is by reflation & doing that will destroy the value of middle class financial assets! In Europe they call it ‘Austerity’ here in the USA it’s known as ‘financial repression’,either way it will break the consumer economy!
            P.S.All of the currency is not an I.O.U. from the government!
            It is an I.O.U from the private bankers who own the Federal Reserve which owns the government!

          4. Yes, there is bank money. You are right about that part. You are wrong about th first part: Government needs to run deficits because surpluses cause money supply to shrink, private savings to erode and a demand squeeze. Financial repression as you call or austeriry is just the opposite of what is postulated by Modern Monetary Theory. In this scenario taxes should be brought down, public expenditure up or a combination of both. Public deficits are necessary for private sector wealth.

          5. That paper argues that the Fed can continue to influence domestic financial market interest rates in spite of falling reserves and technological advances, essentially because “Hey, it worked in the 90s.” That has nothing to do with crashing bond prices in the open market. A central bank can always go out and start buying up those bonds, but if inflation is already the problem, pouring yet more newly invented currency into the markets may be like pouring gasoline on a fire. Maintaining public confidence has far more to do with psychology than with technicalities of interbank transactions as in your paper.

          6. I should add that I have no doubt Brazil is falling prey to neoliberals, nor do I doubt that large banks may have taken short positions whose profitability they will insure through coordinated action if need be. Unfortunately this is standard practice with Latin American economies. I suspect it would be better to get out in front of the bankers by quick, outright default.

          7. I do not think that Brazil needs to default. It’s foreign debt is coming down and the country has a trade surplus. Brazil needs to work in expanding its outuput capacity: that means investments, not austerity.

          8. What inflation? The rate of Brazil is moderate and can be addressed more inteligently through other means. Also, the belief that inflation is a monetary phenomenum is only valid in a full employment situation, hardly Brazil’s situation. It is the relationship between effective demand and real output that determines inflation. http://www.voxeu.org/article/deflation-and-money.

          9. My point wasn’t specific to Brazil, the point was that when a currency is faltering and bond yields are skyrocketing, printing yet more currency to throw at the markets may be counter-productive. Or in other words, there is not necessarily anything the central bank can do to lower bond yields. If the political situation stabilizes they’ll come down, but that’s not under the control of the central banks. A shock default which can credibly be seen as a “one time” partial default might be another way out, but again, the central bank doesn’t make that decision.

            Domestic inflation within Brazil may “only” be 10% per annum, but the real has fallen more than a third against the dollar and its bond yields are higher than Venezuela’s. Again, more for political reasons (defaults tend to follow changes in government), unrelated to central bank policy.

          10. This cannot be so. The central bank can set the interest rates wherever it pleases. The operation of buying bonds merely alters the composition of the balance sheets of the banks. It is not going to increase aggregate spending unless banks use the money to give credit, which may and probably will not happen. I do not see any need for a default considering that public debt is less than 60% of GDP and, in any event, a currency issuing government can never be insolvent. The inflation rate of 10% is not hyperinflation and it can be brought down by adding real output capacity, this means investments, public or private and public spending policies that do not generate inflation (by bidding processes, for example). Depreciation of the real against the dollar would probably not be helpful and is inflationary but it is very costly to try to sustain an exchange rate artificially. It is better to let currencies float. Again, absolutely no need for a default and inflation can be managed.

          11. My comment that they should default was along the lines of “screw the bankers” and wasn’t meant to imply they have no other choice. And yes, I do admit that for a Latin American economy 10% inflation is not particularly high. But, your point about banks not lending just points to the old “pushing on a string” problem of central banks: they can give money to banks, but they can’t make them lend it. Psychologically, however, infusions of brand new money will — after a certain point — further degrade confidence in the currency.

            A central bank can only set interest rates on newly issued bonds by buying all of them, and as far as I am aware (correct me if I am wrong) total debt monetization has never *not* led to a currency crisis. I think we are exchanging ivory tower theories on your part for political hypotheses on my part.

          12. So now the
            Neoliberal crowd is pointing fingers at Brazil and arguing that the country has
            horrible inflation, it is going to default etc… The way I see it is that Brazil
            is a money issuing nation that can never be insolvent, its public debt is less
            than 60% and the country has a moderate trade surplus. The recession has been
            largely self-inflicted by Neoliberal advisors to the government. Yes, their
            inflation rate is 10% but it is manageable. It has probably been caused by
            unwise inflationary spending policies in the past (for example spending for the
            World Cup and the Olympics in a process that is probably based on bidding and cost overruns by contractors that
            will leave a legacy of unproductive and useless sports facilities). Response to
            inflation should be based on expanding productive capacity and not by
            inflicting suffering and unemployment on its population. What do you think?

          13. If Brazil owed money only in its own currency, that would be one thing. But it owes money in dollars and no doubt other currencies as well. Those debts are not manageable via currency devaluation by the central bank. However, I have no argument that the situation has been made worse by neoliberal / IMF advisors, and I am against austerity, so in this I think we’re on the same page.

        1. One of the big problems in society is that the propagandists in the media have kicked a whole set of words around,words that are deliberately vague,distorted.Words that are used to mislead & manipulate the public,these words imply certain things but their meanings are never really explained!No one knows who political liberals are & who are the political conservatives?
          We are playing games with our own minds running in circles chasing liberals & conservatives,left wing against right wing.The truth is it’s all theater!
          The only real antagonists have been around for a long time,it comes down to the struggle between the people vs.the banks & the financial elites who the banks represent.The financial elites are the puppet masters who own the politicians in Washington! These are the parasites who live off of everyone else!

          1. totally agree – well said. The sooner we end the fed AND shrink the federal government down to pre-1930 size, the better. Ron Paul was absolutely correct.

            People keep using words that have little or no meaning – or worse, sound like they mean something good, but do not. The word ‘democracy’ is one. I wish people would just speak plainly and use the words Freedom and Tyranny. Because that is what it all boils down to.

          2. “One of the big problems in society is that the propagandists in the media have kicked a whole set of words around,words that are deliberately vague,distorted.”

            In the old days before PC we called that lying.
            The media could not tell the truth if their lives depended on it.

        2. distinguishing between liberals and conservatives is impractical. you’re presenting a false dichotomy. both of their economic models depend upon considerable welfare and slavery to work. liberals rely upon creating a demographic of chronic victims, taxing everyone else to pay for them (think feminists). conservatives rely upon borrowing vast amounts of money and making everyone else pay for the cost of borrowing (think robber barons). they’re both welfare and slavery at their roots. the mechanisms might be a little different but the consequences are the same.

      1. No. You must be confusing Neokeynesianism with Postkeynesianism. Please read postkeynesians: Bill Mitchell, Randall Wray, Warren Mosler, Stephanie Kelton, Wynne Godley & many others. Neokeynesianism is Keynesianism highjacked by classical thinking. Postkeynesianism, including Modern Monetary Theory, is a progressive school of Economic thought that is precisely providing answers to Neoliberal dogma. Brazil’s government now appears to have fallen prey to neoliberal thugs.

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