Today's date:
Fall 2011

Europe Faces Crisis Brazil Solved

Fernando Henrique Cardoso was finance minister of Brazil from 1993-1994, and president from 1995-2002.

Sao Paulo—For those of us in developing countries who over the years became reluctant experts on the subject of financial crises, the latest wave of turmoil in the global financial system is, regrettably, not a surprise. In large part, the prescriptions and recommendations that so-called experts make today about the persistent problems in the rich world are exactly the same ones that were made in previous decades about countries such as Brazil. The difference is that, now, since the crisis is at the center and not at the periphery of the system, the global risks and repercussions are much bigger.

In the past, national officials—central banks and finance ministers—sought to vigorously demonstrate that there was no reason to compare our own country’s plight with the tragedy occurring in another. Our fiscal situation wasn’t the same; our percentage of debt to GDP wasn’t all that big; the internal debt was in the hands of domestic holders and denominated in local currencies; and so on. But there was always one critical factor: foreign-exchange accounts. If capital flows stopped permitting the rollover of debt, the phantom of default would rear its head and often devour everything, condemning countries afflicted by the contagion to year of fiscal austerity and low growth.

During the 1990s and at the beginning of this century, seemingly every problem experienced by a poorer country (some of them not so poor anymore, since the term BRIC came into fashion) was met with the same prescription. The International Monetary Fund proposed drastic fiscal discipline, a reorganization of the state’s property via privatizations, greater openness to capital flows, new investments and, in the most severe cases, a restructuring of foreign debt, as happened with the Brady Plan. The prescription, therefore, did not assure a smooth path to the return of growth. In order to grow again, it was necessary to lure foreign funds, but at the same time not expose oneself to the most fickle and volatile capital flows, what is these days called “hot money.” Easy to say: But in practice, very difficult to separate the wheat from the chaff. When the situation deteriorated to the point that foreign loans were necessary to cover balance-of-payment deficits, the situation often turned lethal.

What did those of us who ran these countries ask of the international community during these difficult times? We requested more and better international regulation in order to limit speculation against our currencies, the creation of funds that were bigger and more easily accessed, and for the IMF to be strengthened and simultaneously adjust its policies in favor of countries with liquidity crises. To finance these funds, some of us returned to the idea of a Tobin tax, a levy on conversions of one currency to another. Finally, we argued that if budget austerity exceeded a certain limit, it would kill any hopes of a return to growth—not to mention make the sociopolitical situation in our countries unsustainable. Nobody listened to us, despite our continued requests. Countries that were in no condition to negotiate better terms with the IMF generally suffered through a long period without growth, continued inability to pay their debts, and social unrest.

Some emerging countries fared better. Such was the case with Brazil, which of its own accord—and at its own risk—launched the Real Plan in 1994 to create a new currency and make several other structural changes to our economy. We drastically modified the bases of our fiscal policy, cleaning up finances at both the federal and state level, and imposed severe regulations on the financial system that were then monitored by our central bank, in line with Basel guidelines. At the same time, while we undertook privatizations, we did not forget about the need to foster competition in the private sector while also maintaining active instruments of public credit—such as our National Bank of Economic and Social Development (BNDES) and the Banco do Brasil—that would allow our national companies to restructure themselves. In some cases, we created a mixed, private/public system for former state monopolies such as Petrobras. In addition, from 1994 through today, Brazil nurtured policies that would ensure a real increase in the minimum wage and, starting in 2000, created a social safety net—including the well-known “Bolsa Familia” program that links welfare payments to school attendance, reducing poverty and inequality a little as well.

The current global scenario is an uncertain one. The financial regulation proposed at G-20 meetings is facing obstacles to implementation because of diverse national interests. Each central bank operates as it sees fit. The Fed floods the United States and the world with dollars and it conducts operations typical of commercial banks without worrying about orthodoxy. Those responsible for the financial turmoil are not only not punished, but they receive bonuses (in contrast with what happened in the Brazilian program that healed the financial system, which punished bankers). Unemployment won’t come down because there’s neither consumption or investment. The European Central Bank and the IMF demand that those countries in virtual bankruptcy make fiscal sacrifices that simultaneously make impossible a return to growth—and, thus, normality. Interest rates are maintained close to zero and it is declared they will stay there, and economies don’t respond. In Europe, every country makes the fiscal policy of its choosing and there are no mechanisms for unification. Unemployment and political unrest haunt these countries like ghosts, hand in hand with the threat of default.

Emerging economies have escaped this reality, with China at the vanguard. But until when? It’s obvious that a prolonged recession or a large contraction, as Kenneth Rogoff has noted, will transmit to emerging economies its negative effects via foreign trade. Before this occurs and the disaster becomes even bigger, it’s necessary that there be a global understanding. This should start with the recognition that the debts of some European countries are unpayable. Via a restructuring—or whatever people decide to call it – similar to the Brady Plan, it’s necessary to provide relief for the situation of the PIGS and other countries whose situation is similar to theirs. Their internal and foreign debts, and the dire straits of their banks—loaded with assets whose true quality is unknown—give them no choice but to undergo a substantial reduction in the value of their debts for growth to resume. Especially if, at the same time, they’re steeped in fiscal crisis and political unrest.

There will be no political or moral grounds to proceed in such a restructuring unless, at the same time, countries better distribute the burden of these losses. The cry of Warren Buffet, followed by that of millionaires in other countries, lays bare the misguided notions of the Tea Party, which wants to put the onus on the poorest, who had zero responsibility for the crisis. And finally, either the European financial system is rescued by a massive recapitalization program or the euro will fall apart because of its lack of fiscal unity, and/or the European Union will effectively shrink, giving a waiver to some of its members to devalue by using once again their own national currency.

None of this will be accomplished without strong political leaders, willing to redistribute global power and reorganize their fundamental views. Will there be enough strength for such an undertaking? That is the enigma.