Hi, Steve.
Here in Austria, next to the former Iron Curtain, we are definitely concerned about the compromising IMF politics (no longer policy). Taking the money which has been spent during the last year and the non-effects of it, namely the severe meltdowns in Asia, Russia and perhaps next, the Americas, one should ask who benefited from that sort of bailout.
Preserving the exchange rate in a definitely overvalued range does not help a the economy of the weaker part of the countries, as it never cures their shortcomings in their economic base.
But it may provide a chance of exit to foreign investors who could sell their exposure safely, backed by that sort of politics, as long they prevail and do have some stabilizing effect.
Are there other ways to achieve stability? Maybe.
One good, and important example is Italy. Italy is a developed country, at least the industrialized northern part, like parts of spain. But the south of Italy remained a "emerging market" with all negative aspects you can imagine like:
-absolute uneven distribution of wealth (like Brazil), with landlords holding vast agricultural areas, while the rest is employed as contract workers, being laid off and replaced by the cheaper Africans.
-the mob was brought to life in South Italy early this century, Sicilia and Sardegna, just to be planted in Moscow, NY and Chicago. Still and in contradiction of reassurements of Rome's politicians, they hold their claims.
-second economy accounts for more than 20% of Italy's GDP, avoiding taxation.
-frequent turmoils in Italy's regime. Now we count the 51st or 52nd government after the second world war.
Italy shared the fate of many emerging markets in the 70s and eighties. Double digit inflation and interest rates, weakness in currency and underemployment. The major reasons resided in the weak economy with little productivity and output growth and unsustainable trade balances, high but ineffective tax rates and a huge current fiscal deficit.
The italian lira (the currency of Italy) was allowed to float from time to time and then it was pegged again. This policy changed and was influenced by each of the many different acting treasury ministers in either way.
The currency - devalued from some 250 ITL/DEM to 1300 ITL within a decade. As pointed out, sometimes the ITL was kept artificially into a certain bandwidth to a basket of European Currencies, the last time that happened was the years 1992 to 1994. Within two years, money supply exploded in Italy though the official inflation and wage growth rates had been rather tame - they could have been falsified, we believe afterwards. But, Italians flooded their neighbour countries with money, when they made holidays, and Italy was expensive for Austrians. The ever climbing GDP and trade deficit, rising interest rates in Italy and the Lira still pegged, vultures in the form of currency speculators were attracted by this dark figures. In mid-1994 after continuous slow softening, the lira left the European Monetary Union agreements and crashed, after it turned out that the treasury was basically out of foreign currency reserves. It lost almost half of its value, falling from 700 ITL/DEM to the 1300 low in one moment.
Sure it was not a nice day especially for Germany as Italy is one of their major trade partners. It reminds my on the relation US-Brazil, not only seen geographically.
Later on, the lira stabilized, volatility to the EURO candidates decreased and now it is rather stable in the 1000 ITL/DEM area. The only aftermath is the overboarding public debt at around 110% of the Italian GDP (including estimates of the second economy). Unofficial whisper numbers still rank the ratio in the 160% area. Though, the situation improved as Italian interest rates halved and converged to the low DEM interest rates, maintaining some 100 bp spread now, thus easing the service of at least the floating and rolled over debt.
Italy was kept afloat by simply adjusting it's relative value in comparison to other countries, and the financial industry trusted them by providing money afterwards thus gradually lowering italian interest rates. Nowadays it is rather prosperous, though some of its negative aspects remained, especially in the area of politics.
But the dangers prevail: When the EURO starts, the individual valuation of the member countries economies in the form of floating exchange rates is abolished in favor of the EURO. This could mean that one of the most important mechanisms in adjusting each regions economic value is no longer possible and may lead to huge money flows from weaker to stronger economies without the risk of a devaluation.
What that example could show is a possible way for Brazil. Though, it does not mean that tight fiscal policy is useless - even Italy did some of the most urgent needed fiscal reforms and adjustments of the social security system. But it is only of temporary use for the currency as the reasons for the overvaluation cannot be removed by simply injecting fresh money - which inflates the monetary base either way.
I compare it to an overvalued stock where one MM has the bid rigged while the company does a lot of discounted private placements and that additional stock - or money hits the market. At one time, even the toughest MM can't take it any more.
C.
PS: I do not have any position against the real, and I am not calling a quick devaluation there. But - looking the facts and historical examples, it seems really impossible to defend the real at the present level. |
