US
By Neville Spencer
Brazil's financial crisis, which erupted on January 13, had been anticipated since the middle of last year even by those, such as President Fernando Henrique Cardoso, who tried to reassure the markets by denying the obvious. Its potential to spread the Asian and Russian crises through Latin America, and thence to the United States, had also been anticipated, and a bailout of US$41.5 billion had been prepared in advance.
The main cause of the immediate crisis is the pegging of the Brazilian real to the US dollar. Cardoso originally introduced this measure in 1994, as finance minister in the government of Itmar Franco.
His plano real succeeded in its aim of curbing inflation. The consequent media hype helped him to victory in the presidential election that year.
There was never any possibility of Brazil's economy indefinitely sustaining the peg. From around the middle of 1998, Brazil's foreign currency reserves began to evaporate at an alarming rate in order to support the real. From more than US$70 billion at mid-year, they had fallen to US$31 billion by the time of the crisis.
Interest rates of up to 42% were set in order to offer huge profits to investors as an offset against the risks of the expected devaluation.
The announcement by the IMF, the US and other trading partners of plans for a multibillion-dollar economic bailout helped smooth things over for long enough to help Cardoso win another term as president with promises to maintain the peg to the dollar.
But soon after his second term began on January 1, the rate at which capital began to flow out of Brazil's economy picked up and the stock market plunged several times.
On January 7, former president Franco, now governor of the third wealthiest state, Minas Gerais, accelerated the mood of panic by announcing that his state was in financial chaos. He declared a 90-day moratorium on payment of its debts to the federal government.
Most other states seem to be in similar financial situations, though less inclined to be so frank.
On January 13, the president of the Central Bank resigned. A communiqué was issued widening the band within which the real could be traded, resulting in a devaluation of more than 8%.
In spite of insisting that it would not fully float the real, after the stock market plummeted 8.5% on January 14, the Central Bank did just that on January 15. The real ended the week about 20% down.
Domino effect
The worldwide concern about the Brazilian crisis is due to the possibility of it triggering a spreading of the Asian and Russian crises into a global economic crisis.
First, Brazil will almost certainly pull the rest of Latin America down with it. Brazil is by far the largest economy in Latin America, with 45% of South American GDP. It is the eighth largest economy in the world.
Latin America's stock markets have followed Brazil's through this new crisis, as they have done through its previous gyrations. Other Latin American currencies also fell significantly.
Much trade between Brazil and other Latin American countries will be disrupted. In particular, Argentina, which has the largest proportion of its trade with Brazil, will be affected.
Second, the US, which has up to now been relatively unaffected by the crises in other countries, is the imperialist power most closely connected to Latin America. The potential domino effect in the direction of the US is much greater than, for instance, in the case of the Russian economy, which was only half the size of Brazil's and had much less US investment and trade involved when it went into crisis.
Fear of such an outcome prompted a change in the role of the IMF. Seeing the Brazilian problem on the horizon, the IMF decided that rather than try to repair the damage after the fact, it would organise a bailout package in advance to forestall, or at least soften, the eventual financial crisis.
So far, the US has weathered it quite well, with the Dow Jones index falling after the January 13 devaluation but rising again after the January 15 float.
The Latin American financial markets, including Brazil's, did come out overall significantly worse off by the end of the week. Chances of further dramas in Brazil, Latin America and globally are still far from remote.
Austerity
Even before these gyrations of the financial markets, the economies of Brazil and Latin America were already sliding into recession. The new financial crisis in part reflects the slump in economic growth, but it will also deepen the slump.
This has been exacerbated by the falling price of oil, which has severely cut the income of Venezuela, Brazil and Colombia in particular, and also Mexico, where the nationalised oil industry provides more than one-third of budget income.
A fall in the price of copper, by almost half over one year, is hitting Chile, which previously derived 40% of its export earnings from copper.
The IMF is demanding budget cuts from Brazil in order to extract loan repayments and interest. As all Latin American economies are in debt to the IMF and similar institutions, such demands are a matter of course anyway, but the new bailout will give the IMF further leverage to force Brazil to cut its deficit (currently about 8% of GDP) by implementing austerity measures.
IMF officials have been grumbling about Brazil's reluctance to pass harsh austerity measures.
It has been compared unfavourably to the Mexican government, which has enthusiastically cut deeper and deeper into its budget. Mexico recently removed the subsidy on a staple food, the tortilla, causing increased poverty and malnutrition. (At the same time, the government found enough money to cut business taxes.)
Cardoso has had persistent problems convincing legislators to pass measures demanded by the IMF. The conditions of the recent IMF package require tax increases and huge spending cuts to knock the deficit down by 3.3% of GDP compared to last year. No doubt, the government and IMF will be hoping that recent events will scare waverers into accepting whatever the IMF demands.