Brazil's Message: Forget the Global, Think Local
stratfor.com
January 18, 1999
SUMMARY
The decision to float Brazil's real triggered widespread fears that another phase in a global economic crisis is about to begin. Having passed through rounds of the Asian and Russian crises, there is a sense that Brazil's devaluation is part of a greater threat to the international economic system. We do not see this as a global problem, but rather as a series of regional problems. By devaluing, Brazil is clearing the decks of an essentially healthy economy. With this finally out of the way, the long-term investment atmosphere in Brazil actually improves. We not only remain bullish on Latin America, but also are increasingly convinced that to understand international economics forget the global, think local.
FORECAST
The Brazilian decision to float the real shocked financial markets around the world on Wednesday, triggering fears that another round in the global crisis is about to begin. There was a sudden sense that the resilience the world economy had shown since the summer might have been illusory, and that a cancer in the global economy was still gnawing away at its innards. For a moment, it seemed that a legitimate panic was setting in. By Friday, a very different sensibility was in place. The real had fallen about 15 percent, which was not inconsiderable, but did not represent a catastrophic implosion. The Sao Paolo stock market rose 33 percent in one day's trading, while most of the world's markets, save some in Asia, also surged. In a matter of days, the world went from panic to confidence, with emotions cycling as rapidly as markets.
The week's events were fascinating not only because of what they told us about the resilience of the Brazilian economy in particular and Latin American economies in general, but because of what they told us about the global economy. To be more precise, the events in Brazil are telling us that we are not living in a world of global economies that are of one fabric, but of geographically differentiated, highly fragmented economies. Put another way, it is not a small world after all and CNN has not created a global village. It is a very large and complex world, and events in one part of the world may have very little effect on things happening in other parts.
One of the foundations of the great fear of a global economic meltdown is the feeling that the world economy is of a single fabric and that whatever happens in one place immediately effects things happening in other places. This sense of global vulnerability has created a psychology constantly on the verge of panic. Since at any moment something bad is happening somewhere in the world, the global sensibility immediately generates a sense of global vulnerability. Thus, Brazil's problems (or Russia's or Japan's or China's) are immediately seen as a harbinger of global disaster. There is a sense that there is an intractable, global problem that simply cannot be solved and that this represents a fundamental threat to the international economic system. The proof: something is always going wrong somewhere.
Now, in a peculiar contrarian sense, this is all to the good. The hysteria of the month helps to deflate markets periodically and keeps investors on their toes. For this reason, we hesitate to debunk it, especially since it provides excellent buying opportunities. However, there is, strictly speaking, no global financial problem. Rather, there are a series of regional problems, which, while they do influence each other, do not flow from the same cause, cannot be solved by any single means, and do not affect each other nearly as much as people believe. Things may well be terrible in some parts of the world, but that does not mean that the world as a whole is on the brink of catastrophe.
There are three regional crises:
Asia: a crisis developing over the long-term, rooted in public
policies deliberately designed to prevent recessions, that has
permitted massive, systemic inefficiency and unacceptably low rates
of return on capital to undermine the long-term viability of the
region's economies. The problem is particularly severe in Japan,
which is among the few major markets to have declined since
September. Japan's problems are deep, intractable and probably
insoluble without a political smash-up. Nevertheless, Japan and
Asia's problems have had minimal impact on the U.S. and Europe
until now, and we see no reason why it should have a greater effect
in 1999 than it did in previous years.
Russia: the inability of the Russian and other economies of the
former Soviet Union to convert from a command to a market
economy. Essentially, the cost of re-capitalizing the Russian
economy so that it can compete internationally outstrips the ability
of the economy to generate capital internally or attract capital
externally. As a result, any investment in the economy fails because
of a lack of infrastructure needed to support it. The Russian
situation means that German investors will experience massive
losses, but the news from Russia is well known and has already
been discounted.
Brazil: a rapidly developing economy suffering from high capital
demand and tight capital supply, moving rapidly from capital
over-supply to under-supply as the result of quite minor shifts in
relationships. This rapid cycling is quite common in early stage, hot
economies -- as could be seen in Asia in the 1970s. It is not truly
economic dysfunction as much as the immaturity of the Brazilian
economy. Having grown too rapidly, it temporarily outstripped
available domestic and international credit. Not unlike the ASEAN
countries in the late 1970s, the periodic financial crises represent, in
our view, growing pains in an emerging region. The evidence is
fairly straightforward: floating the currency created a quite orderly
devaluation and a 1/3 overnight rise in stock prices. Therefore, we
believe that Brazil's structural problems are probably not as
deep-seated as some might believe.
To summarize: Asia is old and tired, Russia never got into the game, and
Latin America is in an early take-off stage. Far from being a single pattern
of global instability, the crisis represents a rotation between Asia as the
"hot" region of the world and the new emerging "hot" region, which is Latin
America. Russia is irrelevant.
There is obviously some connection between Latin America and Asia, but
it is important not to over-emphasize the connection. Undoubtedly,
psychological elements play a role. Investors frightened by Brazil's
problems will undoubtedly experience an increased degree of caution
when investing in Asia. This should not be overestimated, however, since
Asia has appropriately frightened investors over a year. It is hard to
imagine them being more cautious. Moreover, the structural effect of
Brazil on the financial markets, in terms of contracting available capital, is
not going to be that significant. For some time, there has been a great deal
of hedging on Brazil.
The most important potential influence of the Brazilian market is on the
United States. The American economy is the major engine driving the
global economy. Asia's limited hopes for a recovery are absolutely
dependent on the ability of the American economy to absorb more Asian
exports. The United States increasingly profits from Latin American trade
and a Latin American economic contraction might affect U.S. exports to
the region. This could push the American economy closer to recession,
closing off any hope for an Asian recovery in the next 12-24 months.
This is the most plausible connection between the Brazilian and Asian
crises, but it is not all that persuasive either. The American economy is a
roaring engine. The marginal effect of a Brazilian or general Latin
American contraction will hardly be felt. There is no doubt that the United
States is going to go into a healthy, cyclical recession at some point.
However, the timing of that contraction will have to do with internal
market cycles rather than external events on the order of Brazil.
Moreover, the Federal Reserve has shown itself quite prepared to
respond to international crises by easing money supply. Since the U.S
economy is not showing serious inflationary signs, this may happen again.
Finally, international crises appear to consistently strengthen the American
economy by causing money to flow into American markets in search of
safety.
The Brazilian situation does not, therefore, strike us as a worsening of the
international situation. Rather, it strikes us as a localized event rooted in
the stage of the Brazilian economy and, in some sense, a promising sign of
long-term health in a capital-hungry market undergoing the tremendous
stresses of early-stage expansion. Second, the net effect on psychology
will be minimal. Asia's market psychology cannot depress effective
demand for Asian investment vehicles much further. Finally, the effect on
the United States will not influence the fundamentals driving the American
economy.
The true challenge posed by Brazil to Asia is very different from those
being discussed. By devaluing, Brazil is clearing the decks of an essentially
healthy economy. With this out of the way at long last, the long-term
investment atmosphere in Brazil actually improves. This poses a challenge
for Asia, simply because, in the long run, the devaluation makes Brazil a
more effective competitor for scarce resources with Asia. This is the
ultimate problem. Brazil can work its way through its problems and come
out stronger. Asia, much further along on its economic cycle, has deeper,
structural challenges that are not going to be solved any time soon.
Asia's inability to solve its problems contrasts sharply with Brazil's ability
to take steps that actually matter. This is why Brazil is a challenge to Asia
and not because there is a single, generalized malaise in the world
economy. Asia's problems are its own. Frankly, events outside have little
impact on the course of its problems. In the short term, events in Brazil
contribute to market hysteria, but they should have no long-range effect.
In the long-term, Brazil may become more competitive, but that is only
because of Asia's own weaknesses. The Brazilian crisis does not really
increase our level of concern for Asia as we have been and continue to be
at a maximum level of concern. Brazil doesn't change that at all. What we
are seeing is that there really isn't a single global economy. Rather, there
are a series of regional and national economies, linked in some ways, but
with very separate fates. What happens in Asia does not necessarily effect
the United States very much. What happens in Brazil has little effect on
what happens in Russia.
From a policy standpoint, this is extremely important. The strengthening of
multinational institutions such as the International Monetary Fund is
predicated on the idea that the growing interdependence of the world
means that events in one part of the world endanger economic well-being
in other parts of the world in dramatically new and dangerous ways. If this
premise is true, then it follows that institutions need to be created to
prevent the spread of economic dysfunction. If, on the other hand, the
premise is untrue, then the creation of stronger international institutions
might be worse than the disease. To be more precise, an IMF with greater
power might spread the contagion, by promulgating global monetary and
financial policies predicated on non-existent global crises.
We are fascinated at how not only the Brazilian crisis but also other
regional crises have been regionally contained. The geography of
economic crisis has not only challenged myths of globalization and
economies without borders, but also reinforced, in our mind, the
essentially national and regional character of economic activity. The
Japanese market fell nearly a quarter of its value since July. The American
market is higher than it was. Economic life seems to have a national and
regional cast rather than a global one. Brazil has a crisis. Elsewhere, life
goes on at its own pace and direction. This is important news. |
