Brazil’s Currency Crisis By Team IV ( Chris Trick, Austin Weaver, Tim Moore, Pat Heffernan, Chris Barnes

Why Brazil Matters Biggest economy in Latin America One of the last big countries to attempt free trade and privatization; if this fails international investors discouraged. Unified global economy is threatened if Brazilian currency fails.

History Brazil had been through 6 currencies since the 1960’s In 1994 the Real Plan was adopted Before it were a series of failed plans (the Cruzado Plan of 1986, Bresser plan of 1987, and more) It worked well to tame inflation and maintain exchange rate stability for 5 years

History The Real was initially indexed one-for-one with the dollar It was quickly allowed to float though A policy of high interest rates to discourage speculation and over- borrowing quickly attracted a surge of capital inflows By the mid 1995 the Real Plan evolved into a crawling peg

History Said to be the worst currency crisis in the western hemisphere to date The Real Plan was one of the longest running exchange rate stabilization programs

Facts of Life Before Crisis 43% of Brazilians – over sixty million people - lack the essentials of a decent life One in three children drop out of school without completing primary Drug gangs rule the favelas and the middle class lives behind bolted doors Half a million North-eastern farmers watch crops wither in yet one more drought The urban environment, home to four out of five Brazilians, is deteriorating fast Blacks, over-represented amongst the poor, suffer social discrimination Indians face severe threats to their economic and cultural survival The income gap between men and women is the worst in Latin America

Why Peg to Dollar? Needed to convince domestic and international investors that chronic inflation would be stopped. Before Real Plan, inflation was 3000%. Fixing the exchange rate was easier then reducing government commitments.

The Fall It was in a financially fragile state It required large capital inflows to build up the central bank to defend currency This built investor confidence and led to exchange rate appreciation This fueled import-driven consumption and stifles export growth In order to attract the inflows the real interest rate had to rise

The Fall The high interest rates lead to a rising debt burden and a deteriorating fiscal balance A rising budget deficit and deteriorating trade balance inevitably lead to devaluation It just could not finance its current account deficit due to insufficient long-term instruments

The Fall Investors came to believe the capital inflows were insufficient to finance its current account deficit Productivity did grow from the imported capital goods The industrial restructuring it caused was not enough to fight off the deteriorating trade balance as unemployment rose

The Fall Speculative pressure built up and it became harder and harder for the central bank to maintain the rate Eventually the peg had to break; calling for a floating rate.

Other Reasons The political power of the elite prevented tax hikes and to encourage exports it could not impose higher taxes on manufacturers The public sector had won generous pensions and benefits that the government could not afford any longer Dismantling these programs would have led to further social instability

Other Reasons Given the political paralysis it is difficult to see how the prolonged overvaluation of the currency could have been avoided

How Much Was Lost During the first 6 months of speculative attack currency loss totaled $35 billion!!! After the first 3 months of 1999, US reserves went from $70 billion to about $32.9 billion.

The Fall

Foreign Influences The other currency crisis in Asia, Russia, and Mexico made the peg increasingly fragile Short-term capital flew faster into Brazil and the government had to sell off 10 billion dollars in reserves and hike interest rates from 21 to 44 percent This worked for a short time until the crisis hit January of 1999 unexpectedly

Decline of Reserves

Crisis Recovery Managed a quick recovery compared to other major currency crisis to date. Due to banking system being ready to handle both severe economic shocks and policies. Commercial banks able to take extreme measures to calm and stabilize markets.

A guy who came to International Finance for the first time, was a wad of cookie dough. After a few weeks, he was carved out of wood. -Johnny Stiver