Erdogan Syndrome: How much would it cost Brazil to break with the markets?

Perhaps as a natural reflection of the political debate, the economic debate in Brazil has heated up and, like the political debate, there has been no room for nuance.

PFor Lula and several of his allies the terms are those of the class struggle: on the one hand the poor, wage earners and their so-called political representatives; on the other hand, businessmen, you renters and you ideologues neoliberal them. These are to blame for all the setting up economic problems plaguing the country: inflation, high interest rates, precarious jobs, stagnant growth, inequality.

In these terms, it’s time to ask what separates the unorthodox Eden from the constraints of the real world. Which proposes a break with the current subordination Public finance global financial markets must start answering how to deal with what would follow the this breakup.

Let’s start with interest rates. Last week, Lula suggested that part of the blame for high inflation should lie with high interest rates, just like her Turkish counterpart, Rec.AndP Erdogan, it has been for years. At the height of his rhetorical rapturethe President invited us to dream: We may not even have sworn…

well, get awayon That impossibilityhow to produce a forced drop in interest rates?

First, it would be necessary revoke the autonomy of the Central Bank, now guaranteed by law – perhaps forcing the majority of current council to resign. expired this uncomfortable, that would be enough set the rate of Selic next to zero and – Here you are! – we would be in the wake of development.

But the reaction of the markets would be in between. about 9,5% of the stock of domestic debt securities – just over R$ 530 billion – is now held by foreign investors, who receive what they see as attractive remuneration for leaving some of the money they manage in Brazil.

Selflet’s say, half of that money believing that there are better options in the world to receive, in the future, reais without interest rate adjustment, we would be talking about an outflow of more than 100 billion US dollars – more than two years of the trade balance projected by the Central Bank for this year and a third of the stock of international reserves.

It seems unlikely that a request for exchange reais for $100 billion doesn’t interfere with the exchange rate. But here even the heterodox government can make choices: let the market find the exchange rate that balances it new question with the supply of dollars in the country (including the willingness of the Central Bank to dispose of reserves – but at what price?) or take the opportunity to also implement capital control measures, preventing money from rushing out of the country and real devaluations.

Whatever the solution found for the streams immediate, no matter how successful it is, will result in a price change for future flows. Those who are putting dollars into the country to receive them in the future will ask for a higher remuneration for the risk of not receiving their money when they want, not to mention the uncertainty about the conversion rate.

It is likely that the foreign investor will only agree to lend to government or Brazilian companies receive in hard currency – as has been the case here for a long time e isuntil today, for countries that cannot guarantee a minimum of stability to their currencies.

Well, fuck the foreigners ungrateful, we let local savers finance our debt. A functioning interest rate futures market would likely find the low interest rate policy unsustainable and drive up long-term borrowing costs. (the yield curve) on the heights. No problem: the government interventionist it could choose to issue only securities indexed to the Selic rate or mandate the Central Bank to manipulate the entire curve and tabulate the longest interest.

The name of this is financial repression, forcing savers to finance the government at rates close to below inflation. In that process, there would be more demand to convert household savings into any hard currency and get the money out of here. more controlSt of capital and the creation of a taxSt parallel exchangeSt would probably follow.

The new low interest rates would also lead to an acceleration of inflation, either through a more depreciating real or an increase in demand without a match for supply. The all-powerful government could intervene here as well, manipulating prices or inflation rates. Nothing that has never been done here or anywhere else.

After all this crossing, which has everything to be painful, we will have cut our dependence on the accursed speculators and we will be masters of our economic destiny. TOwhere is it will he catch us?

Today isAmong the large emerging economies there are two remarkable examples of countries whose economic management has decided to escape the discipline imposed by the financial market.

In 2018 the Turkish president declared war on his central bank, showing intention to control the monetary policy of the country from your interpretation alternative of the causes of high inflation (“Interest rates are the mother and father of all evil,” he declared at the time).

Since, the command of the central bank was changed three times, annual inflation has never returned below 10% (it was 36% in 2021 and 64% last year) and the Turkish lira has lost almost 80% of its value against the dollar. The share of the stock of domestic debt held by foreign investors fell from 19% to 2017 to less than 1% in November 2022, latest data available.

The recent history of Argentina is improve known around here, so I’ll leave just a few illustrative numbers. At the end of 2003 the exchange rates of the Argentine peso and the real against the dollar was similar: 2.90 of one of the two currencies he bought one dollar.

Today, worth a dollar BRL 5.10 (and Brazil is far from being a model of exchange rate stability); in argentinian, between 180 and 380 pesos, depending on who buys it – there are specific fees for importers, payments for streaming services, payments for international concerts (the famous “Coldplay dollar”) and so on. Average annual inflation in the five years before the pandemic was 38%; in 2022 it finished just under 95%.

In both cases, the break with the international financial market it has increased the degree of discretion of macroeconomic policies – at the costs described above.

What heterodoxy sells as “submission” to the markets is the acknowledgment that the holders of debt securities and shares expect returns calculated on the basis of assumptions that certain macroeconomic variables are maintained. If these assumptions alter those returns, asset prices change; if for any reason, the market doesn’the can fitsrthere is the alternative of suffer damage e take your money elsewhere.

To use the terminology of the great Albert O. Hirschmannif investors do not make themselves heard (voice) to resume something closethe original terms of their contracts simply choose to walk away (Exit).

what againAnyone advocating for the break with markets needs to grapple with these costs and say why their version of the break will be different from the dynamics described above and from the cases of Turkey and Argentina. It is necessary overcome the magical thinking that Brazil can operate in a fantasy world where actions generate no reactions and that macroeconomic policy is only limited from the lack of will and imagination of those who defined it in the past. Other than that, what’s left are in bravado or plain nonsense that have cost us so much throughout history.

Luciano Sobral is chief economist of NEO Investimentos.

Luciano Sobral

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