U.S. Won't Sing Brazil's Blues

Dec. 21, 2004

Despite the devaluations in Southeast Asia, Russia, and Brazil -- and their negative impact on Europe and Japan -- the American juggernaut continues to steamroller the rest of the world. It just shows what can be accomplished with a balanced budget, a credible monetary policy, and a government so hobbled by internal scandals that it cannot pass legislation that damages business. Once again, the decision to float the Brazilian real has shown that fixed exchange rates are never the right idea. They are only an artificial prop to try to convince the rest of the world that an economy is performing well. If it is, fixed exchange rates are not necessary: the market will stabilize the value of the currency. If it is not, as we have seen time and again, staunch government statements that the currency will "never" be devalued are worthless. A great hue and cry has been heard recently about how the drop in U.S. exports to Latin America will reduce the U.S. growth rate this year. We have been through this before. A year and a half ago, the consensus was that the collapse of Southeast Asia would take a big bite out of U.S. growth. The latest evidence: 0.0%. U.S. exports to Brazil in 1999 will indeed fall more than previously anticipated. However, I haven't revised my forecast of 3% to 3.5% growth for the U.S. economy this year. The devaluation of the real won't reduce real growth any more than the collapse of Southeast Asia hurt the economy last year. Yet some would argue this forecast ignores the greater importance of Latin America to the U.S. economy. The argument in this case is a little different. Last year, weakness in the Asian economies caused the biggest drop in commodity prices since the end of the Korean War, and interest rates fell sharply. Commodity prices won't fall further this year, and interest rates probably won't be cut any more, either; they may even rise later this year. So there have to be other reasons why devaluation of the real won't hurt. The Brazilian devaluation had been so widely expected in U.S. financial markets that most investors weren't affected. It was nothing like the shock that occurred when Russia devalued. More telling, Brazilian financial markets also breathed a sigh of relief when the float was announced and the Bovespa (Brazil's blue-chip stock market index) rose 33% the same day. In 1997, when the Southeast Asian currencies collapsed, so did their stock markets. However, the basic difference is even more fundamental. When the Southeast Asian currencies collapsed, growth in those countries plunged from +8% to -8%. By comparison, Brazil already is in a serious recession -- and what country wouldn't be, with interest rates in the 35%-to-40% range, compared with an 8% rate of inflation. The Brazilian recession was in the midst of dragging down the economies of Argentina, Chile, and Mexico, as well as the lesser lights of Latin America. With the float of the real and the return of interest rates to normal levels, the Brazilian economy will rebound. U.S. exports to Brazil will decline this year because of the cheaper currency, but faster growth in the rest of Latin America will offset any other devaluations that might occur in that region. On balance, U.S. exports to Latin America will be no weaker than if Brazil had not devalued. The question of whether the Brazilian economy will recover depends on whether it can put its own fiscal house in order. If the legislators continue to vote triple pensions to themselves while remaining in office and continue the spoils systems of awarding lucrative government contracts to themselves and their friends, the economy will continue to stagnate. Conversely, if the deficit can be reduced to manageable levels, the economy will rebound, and the real will stabilize in world markets. It isn't up to the International Monetary Fund to supply zillions of dollars; it's up to Brazil to realize it cannot prosper unless its bloated deficit can be controlled. Michael K. Evans is president of the Evans Group and professor of economics at the Kellogg School of Business, Northwestern University, Evanston, Ill. His e-mail address is [email protected].

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