Brazil's Monetary Illusions--and Ours
January 21, 1999
(note: WSH editorial)
By Judy Shelton, a professor of international finance at DUXX
Graduate School of Business Leadership in Monterrey, Mexico. She serves on the
board of Empower America in Washington.
Brazilian officials went into last weekend stating that they would announce their
country's new foreign-exchange policy on Monday. After the prior week's horrendous
bout with money meltdown, they were contemplating three options: (1) setting up a
currency board similar to the one in neighboring Argentina that would require
one-to-one convertibility with the dollar; (2) widening the trading range for the value of
the Brazilian currency, the real, against the dollar, with the central bank intervening in
the foreign-exchange market to support the real as necessary; or (3) simply allowing
the real to float freely.
The official announcement came on Monday as scheduled. Surprise, they went with
floating. In truth, however, it is difficult to distinguish the third option from the second,
as the new central bank president, Francisco Lopes, also insists that the government
will intervene in an "occasional and limited form" if there are any "disorderly"
exchange-rate movements. He also announced a surprise increase in interest rates--the
prime lending rate has now been raised to 41%--in order "to minimize excessive
exchange-rate volatility and consolidate price stability."
Some observers have hailed the plan as bold. It isn't. It isn't even a plan. It is a
mix-and-match approach to manipulating the value of the nation's money that serves
the interests of government at the expense of citizens.
Intellectually, Brazil's new policy is shamelessly muddled. If the currency is to float
freely, the government should have a strictly hands-off policy.
How can the market determine the appropriate value for the real if a significant portion
of the seeming demand for the currency is actually just the Brazilian government buying
up its own money, attempting artificially to prop up its exchange rate against the dollar?
By hinting that it will support the real without specifying the trigger points for
intervention, Brazil's central bank has retained its trading-band mentality; it just isn't
showing its cards to consumers or investors.
As for raising interest rates, it's clear that in a country that long ago figured out how to
index costs, higher interest rates will feed inflation rather than combat it. The higher
cost of borrowing will be passed along in the form of higher prices for goods
produced. The latest move has less to do with fiscal discipline than with trying to
wheedle skeptical outsiders into holding an undependable currency.
Even worse, the new monetary policy is morally bankrupt. Brazil's inflation rate in
1993 was 2,700%. The Real Plan was adopted the following year as a radical
measure to gain some semblance of economic sanity by closely tying the value of the
national currency to the dollar. The plan worked--Brazil's inflation rate was 1.5% last
year--and a grateful citizenry re-elected President Fernando Henrique Cardoso, who
was granted near-hero status for making good on his promise to put the nation on a
sound monetary footing.
Of course, political leaders routinely break promises. And the decision to sacrifice the
credibility of the real was no doubt painful for Mr. Cardoso. But it was clearly even
more painful for Gustavo Franco, the former central bank president, who strongly
resisted devaluation in the face of attacks by businessmen, trade unions and
politicians--before finally succumbing to pressure to resign. "People do not realize the
extent of the stress and solitude that comes from the defense of principles and policies
directed at the majority, which are opposed by powerful interests." he said.
Speaking of powerful interests, where does the International Monetary Fund figure in
all this? IMF authorities, together with U.S. Treasury officials, were initially miffed by
Brazil's move to floating rates. After all, the whole premise behind the $41.5 billion
loan package arranged for Brazil in November was to provide conspicuously sufficient
reserves to intimidate speculators from making a run on the real. When they did
anyway, cashing out $4 billion worth in three days, the deterrent value of the financial
war chest was obviously shot.
Not to worry. The ultimate enabler, the IMF quickly reconciled itself to being
disregarded and moved to embrace Brazil's new policy. After a weekend of meetings
in Washington, IMF Managing Director Michel Camdessus declared he was "satisfied"
with Finance Minister Pedro Malan's "useful clarification" of Brazil's objectives. This
even though the 22% decline in the value of the real since last week means it will be
that much harder for private companies and the Brazilian government itself to pay back
dollar-denominated debts. What's more, the devaluation will undoubtedly worsen the
recession that had already been projected.
What is truly worrisome is that the very exercise in monetary futility conducted by
Brazil in global currency markets last week--attempting to stabilize exchange rates
within a defined trading range through central-bank intervention (or the threat of it)--is
now being pursued at the global level, one suspects with the blessings of the IMF.
Keizo Obuchi, Japan's prime minister, has been meeting with his counterparts in
Europe to enlist them in his push for "tripartite cooperation" between Japan, Europe
and the U.S. to stabilize exchange rates among the yen, euro and dollar through active
government management.
German Chancellor Gerhard Schroeder, already predisposed toward the concept of
exchange rate "target zones" promoted by his outspoken finance minister, Oskar
Lafontaine, is now suggesting that such an arrangement should be seriously discussed
at the scheduled June economic summit of the Group of Seven in Cologne. "The basic
principle that laissez-faire is not a correct policy for these markets has established
itself," according to Mr. Schroeder, who asserts there is common agreement among
the major powers on this point. President Clinton's reference to the upcoming summit
in his State of the Union speech, coupled with proposals of his own for a new
international financial architecture steeped in the Keynesian tradition of
government-knows-best solutions, provides an eerie echo on the global stage.
There is nothing wrong in wanting to put a human face on capitalism. But it should be
the face of an entrepreneur, not a bureaucrat. Entrepreneurs need money that functions
as a meaningful unit of account and a reliable store of value. The problem with schemes
that seek to impart integrity to money through the pronouncements and manipulations
of government authorities--including "crawling peg" approaches or other complex
formulas that fall into the oxymoronic category of managed float regimes--is that they
are based on the rule of men, not the rule of law. They are thus vulnerable to political
expediency.
Contrast the notion of managed exchange rates, trading bands and dirty floats with the
straightforward approach to money taken by Argentina. In 1991, led by former
Minister of the Economy Domingo Cavallo, Argentina passed a convertibility law that
requires every new unit of money to be backed 100% by currency-board holdings of
U.S. dollars. Citizens can exchange pesos for dollars on a one-for-one basis; they are
interchangeable. Notice the critical difference? Individuals are empowered by the right
to convert their money at a fixed rate into a currency they trust. They are not passive
victims of government fallibility in monetary matters.
Instead of the keep-'em-guessing nature of discretionary monetary authority, as
exercised by most governments in the name of preserving "flexibility," Argentina has
opted to permit its citizens to make economic decisions free from monetary illusion. No
stimulating of the economy through inflation, no improving the "competitiveness" of
exports through currency devaluation. Just money that works.
In comparison, for all the good accomplished in Brazil over the 41/2 years it enjoyed a
stable currency, in the end the Real Plan proved not radical enough. Certainly not as
radical as transferring power away from government and granting it to private
individuals, who, after all, are the economic agents of productive growth. Convertibility
conveys choice--the ultimate guarantor of democratic capitalism.
Now if only we could make the dollar as good as gold. Then we could start talking
seriously about a global monetary system based on fixed exchange rates. |
