BY NOT ADAPTING TO A NEW ENVIRONMENT, BRAZIL IS CEDING ITS FUTURE TO CHINA

Leo Tolstoy’s description of Napoleon’s 1812 invasion of Russia, in his masterpiece “War and Peace”, evokes the dynamics in the currency war taking place in global finance. Napoleon lost to the Russians, though he was the stronger. The weaker Russians adapted their strategy to circumstances – pulling the French farther and farther from their supplies until they became too weak to win. The French lost 90 percent of their soldiers, the war, though they had won every major battle, and Napoleon lost both his renown and his empire. His mistake was in not retreating when the scenario had changed. He lost to the illusion of a different reality.

Currently, there are no cavalry charges or bayonet attacks, but the currency war is destroying uncompetitive factories and shrinking economic horizons around the world. And it’s not clear whether any of the traditional powers are doing what Tolstoy’s heroes did: adapting their strategies to changing circumstances.

If anyone is winning now, it’s China. In twenty years, China has quadrupled the value of its GDP compared to Brazil´s and becoming the world’s second largest economy. Projections suggest that it will continue growing faster than the rest of the world in the coming years.

The Chinese strategy has three pillars: increasing productivity; generating surpluses to have more resources in the future; and sustaining consistent economic policy for the longer term. China’s execution of this strategy is disciplined. An example illustrates China’s determination. In less than three years China decided to build and then built a new airport for the Olympic Games. Brazil, by contrast, has been discussing a third air terminal in Sao Paulo – the largest economic center in the country – for thirty years – nothing has been done so far.

As time goes by, China gets stronger. It has a trade surplus, so each extra dollar of reserves provides an income and financial resources to invest in schools and roads to continue growing. It is unreasonable to expect them to change what’s working well. The world may protest, but China will continue the policies it needs to build a future, including its refusal to devalue the renminbi.

Brazil has a different three-pronged strategy: debating about the future, lobbying against China´s exchange rate policy, and buying foreign currencies to keep their own as cheap as possible. As interest rates in Brazil are much higher than abroad, it means that more if its tax-revenue is being directed offshore and leaving less of tax revenues for economic investments at home. Thus, even as Brazil faces growing competition from the cheap Chinese currency, they are losing the tax revenues they should be investing in their own economy.

This kind of “reserve policy”, now in place in Brazil competing against China, breeds its own vicious cycle. The more foreign currency Brazil holds, the safer it seems to foreign investors. In the face of shaky global markets, that means foreign investors are increasingly prepared to buy Brazilian bonds – forcing Brazil to send more of its own tax revenues abroad to pay their interest.

Maintaining the current strategy will only worsen the scenario for Brazil. What was once a remedy has become a poison. Projections indicate that Brazil’s GDP will grow below the world average in 2011 and some sectors of the domestic industry are losing market share abroad – and what’s worse – internally, too. Brazil’s external accounts are deteriorating. It is not an alarming picture yet, but the picture shows the need for improvements.

Brazil could change course now, with a new president in office and relatively sound economic fundamentals. But this means Brazil has to change the way people think about its currency, the Real. The Real is, in fact, not a strong currency; it is an appreciated one. And the debts related to its past appreciation will have to be paid one day.  Blaming the Chinese for the exchange rather than changing what happens will not result in anything.
More specifically, on the exchange rate issue, in the current macroeconomic regime the Central Bank must accept the reality of the Real’s value against the Renminbi and other currencies. With lower interest rates and the exchange rate more devalued, the country will attract the investments that suit it better – ones that increase its ability to generate wealth.

Brazil has to move on, to overcome the three pillars of a decade ago: flexible exchange rate; inflation targeting; and fiscal balance.  It needs to adopt a more ambitious strategy that includes: improvements in productivity; the removal of bureaucratic acronyms; modernization of the institutional framework; the improvement of public administration, including the composition of revenues and expenses; and building policies to improve the country’s productive base.

Tolstoy’s work reveals the destructive potential of an illusion when it is not balanced with an objective view of reality. Brazil can do better.  It needs to do better.

By Roberto Luis Troster
Doctor in Economics

 

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BACKGROUND

Twenty-five years ago, the governments of France, West Germany, Japan, the United States and the United Kingdom gathered at the Plaza Hotel in New York City to create an agreement on interventionist policies in currency markets. The resulting Plaza Accord, signed on 22 September 1985, laid out a framework of policies to devaluate the dollar in relation to the Japanese yen and the Deutsche Mark and was considered a high-water mark of international monetary co-operation.

Fast-forward twenty-five years, and we see an entirely different picture. Countries today tend towards adopting uncoordinated and unilateral efforts to intervene in currency markets to their own advantage. Interventionist policies aimed at achieving low exchange rates for home currencies are threatening to spiral into a currency war as countries aim to boost exports and capture a larger market share at another’s expense.

Many states recently have experienced upwards pressure on their exchange rates and have partaken in the on-going arguments about currency intervention. The most notable area of conflict has been the US-China argument over the valuation of the renminbi. The US has put pressure on China to raise the value of the renminbi and threatened to impose trade sanctions in light of Chinese non-compliance. By devaluating its currency, the US argues, China has rendered its exports more competitive in the world stage and has stolen jobs from the United States other countries.

In September 2010, in a speech in Sao Paulo, Brazilian Finance Minister Guido Mantega warned that an international currency war is underway. At the time, the Brazilian Real was at a 10-month high against the dollar and was described as the world’s most overvalued major currency by Goldman Sachs analysts. For many emerging economies, intervention is needed for coping with volatile capital flows. Pervading low interest rates in the developed world has resulted in massive foreign capital inflows into emerging economies. In response, emerging-market central banks have taken steps to restrain the pace at which their national currencies appreciate.

In the developed world, a growing number of countries also felt pressured to stop their currencies from rising against the dollar. In November 2010, Japan intervened in the currency markets and sold USD23.6 billion worth of yen in an effort to weaken its national currency. On 14 October 2010, an announcement made by Germany’s economy minister warned of a trade war if countries “continue to hold down the value of their currencies”.

There is, however, still a possibility for international monetary cooperation: A recent G7 decision to support the devaluation of the yen through a coordinated intervention in currency markets is reminiscent of the Plaza Accords of twenty-five years ago. The G7 pledge was delivered on 18 March 2011, a day after the yen hit an all-time high against the dollar – a level that threatened Japan’s exports and appeared to hamper its economic recovery after a devastating earthquake.

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