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Braudel Papers - Nº 16, 1996
Is
Brazil headed for a Mexico-style crisis? Some parallels
warn us of coming trouble. Much depends on the struggle
for moral and political cohesion led by President
Fernando Henrique Cardoso, who is trying to manage
institutional problems that dwarf anything seen in Mexico
in recent years. Brazil’s multiplying financial
difficulties now exceed those of Mexico in late 1994. Some differences between Brazil and Mexico may be more important than the similarities. Although Brazil has been bloodied over the past decade by alarming escalation of civil violence, it has suffered no political trauma like the Zapatista revolt in Chiapas in January 1994 or the assassination of Presidential candidate Luís Donaldo Colosio in March. Brazilian economists like to say that "inflation wounds but a foreign exchange crisis kills," but the maxim applies more to Mexico than to Brazil. Unlike Brazil, Mexico has clung to fixed exchange rates for most of the past half-century. Each devaluation —in 1953, 1976, 1982 and 1994, usually near the time when the Presidency changed hands— has caused a political shock. The Mexican shock was aggravated by President Carlos Salinas de Gotari’s refusal to adjust the exchange rate after the August 1994 election because devaluation might spoil his candidacy to head the new World Trade Organization. Brazil avoided such devaluation crises over the past generation by indexing its exchange rate. The Bank of Mexico was accused of loose monetary policy when, facing investors’ resistance to holding government debt, it expanded credit, making it easier for speculators to buy dollars and bet against the peso in 1994. Brazil now is loosening credit to lower interest rates and avoid recession in an election year. Both governments took short-term portfolio investments from foreigners, the difference being that Mexico’s tesobonos were denominated in dollars while Brazil’s new public debt is in local currency. A bigger difference is that Brazil has no hope of a rescue, if needed, on the scale of the $52 billion support package for Mexico in early 1995 arranged by the U.S. government, the International Monetary Fund and a group of central banks, one of several assistance efforts for Mexico since 1976. Brazil has no leverage on U.S. politics like the threat of disorder across the tense U.S. border with Mexico, especially so soon after creation of NAFTA (North American Free Trade Agreement), whose collapse would hurt President Bill Clinton’s chances for reelection. Edward M. Truman of the U.S. Federal Reserve Board warned later that "the scale of potential financial assistance needed to stave off a full-blown crisis in Mexico has proved to be much larger than anyone could have imagined as recently as 1994, and the scale of any similar operation in the future (even allowing for the special circumstances of the Mexican case) is likely to be larger than the official sector will be able or willing to assemble." Differences between Brazil and Mexico go deeper, especially in terms of political institutions. The histories of the Bank of Mexico and the Central Bank of Brazil show these differences. The Bank of Mexico was created in 1926 in the wake of the chaos and hyperinflation of the Mexican Revolution, pursuing conservative policies in the next half-century. While criticized at times for lack of independence in monetary policy, the Bank of Mexico’s influence on government is shown by the fact that two of Mexico’s three most recent Presidents, Miguel de la Madrid (1982-88) and Ernesto Zedillo (1994-2000) emerged from the ranks of its career officers. While only four Governors headed the Bank of Mexico since 1953, the Central Bank of Brazil had 21 Presidents since it began operations in 1965, 14 of them since military rule ended in 1985. Between 1953 and 1994, the price level multiplied six-fold in the United States and 1,571 times in Mexico while Brazilian inflation shot into Outer Space, multiplying prices something like 33 trillion times. In 1994, the year of the peso’s collapse and the launching of the Real Plan, Brazil’s inflation was 2,669% while Mexico’s was 7%. Institutional differences like these enabled Mexico to carry out three successful efforts at fiscal stabilization since 1982 while Brazil moved to the brink of hyperinflation in 1990 and 1994.
Mexico’s more stable institutions were built upon
bitter lessons of the political and economic disorder of
the Mexican Revolution eight decades ago. Having suffered
no such convulsion so far, Brazil has enjoyed the luxury
of learning more slowly. Thus Mexican Presidents are more
powerful than Brazilian Presidents. For nearly seven
decades Mexico has been under a one-party system that is
evolving painfully now into a more democratic three-party system, while Brazil’s atomized multi-party system
seems chronically unable to muster stable majorities in Congress. The reins of power in Mexico are held by a
federal bureaucracy, while in Brazil power is spread
among Congress and state governors skilled at extracting
money from the Executive in exchange for different kinds
of political support. While Brazil’s Treasury has avoided the exchange
rate risk assumed by Mexico’s government in using
dollar-denominated tesobonos to fund its internal debt,
other danger signals are surfacing that appeared in the
months before devaluation of the Mexican peso. As in
Mexico before 1995, the currency is overvalued against
the dollar. In The Economist’s widely quoted Big Mac index, a hamburger in São Paulo costs roughly 20% more than the average of other major cities in the world. The government adds to pressures on the real by borrowing too fast and too much. Private business adds to the debt burden by taking dollar loans like crazy to arbitrage between low international and high domestic interest rates. Both Brazil and Mexico have been flooded with hot foreign money, little of which was invested in productive facilities. Since the Real Plan was launched, federal debt has grown more than twice as fast as reserves.
Over the past year, state and federal debts have grown
from $80 billion to $206 billion, while reserves
increased from $40 billion to $60 billion. In Mexico,
public debt grew only slightly in 1993-94 but became more
dependent on foreign financing that dried up amid the
political convulsions of 1994. Mexico’s government
was a net saver in the four years before the peso’s collapse, while Brazil’s public savings have been
chronically negative over the past generation. However,
Mexico eased its fiscal policy in 1994 as the Bank of
Mexico and development banks pumped money into the economy. What sunk Mexico’s international
credit,
aside from political violence, was a rising current
account deficit in 1991-94, approaching 8% of GDP.
Brazil’s strategy, on the contrary, is to support an
overvalued exchange rate by increasing its reserves even
more while avoiding foreign imbalances like Mexico’s
by financing exporters at international rather than
domestic interest rates. So far, this strategy has been successful. Brazil’s current account deficit was
contained at 3.1% of GDP in 1995, at a cost of rising unem-ployment, but this balance may weaken because of
disappointing trade figures in 1996. The big question is
whether these balances can be controlled if devaluations
keep lagging behind inflation, making dollars even cheaper, in the face of credit expansions driven by
foreign borrowing, falling domestic interest rates and
bailouts of banks and state governments. |
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