What’s going on with the Brazilian currency? Like many ’emerging market’ countries around the world, Brazil has recently been unpleasantly reminded just how linked its fortune is to the decisions of the United States, and the Federal Reserve. The real has been all over the place since 2008, making things quite difficult here, and that has relatively little to do with what Brazilian politicians have done.

Take a look at the chart above to get an idea what a headache running a developing country has been since the 2008 financial crisis, and especially since the US Federal Reserve, which controls the global supply of dollars, began talk of ‘tapering’ earlier this year. ‘Tapering’ is Federal Reserve-speak for going back to the way the US Central Bank used to do things before 2008, which in practice means much less cheap money floating around the globe, since the Fed will slow down its direct asset purchase program (background here). The process of tapering is the first step towards stopping the Fed pumping extra money into the US economy, and (probably) the first step towards raising interest rates.

Just the possibility that the tapering might happen crushed the Brazilian real down to 2.45 against the dollar, from a high of 1.55 just two years ago. How can you create economic policy in a country in which the cost of both your exports and imports swings so violently, and how do you explain to your citizens that yesterday they could traipse around Argentina (and Miami and New York) buying everything, but now, really won’t be able to afford that trip to Europe (or even to Paraguay)?

Since 2008, Brazil’s currency became much too strong for its own good, and then also lost value much too quickly. As if Brazil needed further proof of how dominant the influence of the Fed is here, when we got wind that the ‘tapering’ wasn’t actually going to happen as soon as had been thought, the real jumped back up to 2.2. Maybe it will stay around there. Some credibly think it will have to hit 2.65. We don’t know.

Brazil’s government has made some very real economic mistakes in the last few years. But the pseudo-tapering debacle has reinforced the uncomfortable fact that at least in terms of the currency, Brazil has been on a roller-coaster since 2008. And except for small interventions, it is not President Rousseff or Finance Minister Guido Mantega doing the driving. The real protagonists here are huge flows of international capital, swooshing around the world, guided by the noises coming from the central bank of the United States.

Recent history

But of course banks aren’t required to invest in the US, and many quickly caught on that they could make a killing getting free money in the US, and then investing in growing emerging market countries where they could earn easy returns. This was especially true in Brazil, where interest rates have long been punishingly high for borrowers and a free meal ticket for investors. Brazil was also riding high on a decade-long Chinese commodity boom, and the government had a card up its sleeve to pump up the economy further in response to the crisis (basically, pump credit into the economy so that new middle class Brazilians could buy consumer items and pay the super-high interest rates), and so dollars poured into the economy.

By 2010 the economy was growing by 7.5% annually and was a darling of international investors (and those of us in the international economic press), and by 2011 the currency hit a high of 1.55 reais to the dollar. This meant it was extremely, extremely overvalued and virtually guaranteed to kill off Brazilian manufacturers that now found their goods too expensive to sell abroad – Mantega had railed against the US dumping so many dollars into his country and started the largely ineffective ‘currency war’ as a response in 2010. Nevertheless, the super-strong real generated a lot of positive press and confidence here in Brazil. Travelers felt rich. The Brazilian stock exchange had some spectacular years ‘in dollar terms.’ Brazil’s economy got larger than the UK’s. Eike Batista got far too rich as excited and cash-flush foreigners bet on his slightly exaggerated dream.

Since then, the realities of the Brazilian economy (not actually so dynamic outside of agricultural exports and credit growth) combined with some major mistakes in the Dilma administration (which of course got much more attention than they would have had they happened during the upswing) and growth inevitably slowed back to previously normal levels, and then almost ground to a halt last year. In the background, the US began to feel confident in its own recovery, and it became increasingly clear that a whole bunch of shale gas in the ground could power an energy boom.

Despite the solid long-term foundations of the Brazilian economy, the chaos in Brazil’s currency in the last few months has been about the Fed switching its strategy back to normal. The money river is drying up and the money went pouring back the other way, to the US. Or at least ‘markets’ remembered that they will. The peaks in dollar strength in that chart correspond exactly to those two points.

Much to the chagrin of everyone down here, we’ve been reminded that Brazil’s place in the global economic system is often more important than the national headlines we’ve been chasing. Even worse, they’ve realized it’s all about Uncle Sam all over again.

What can be done

Many thought Rousseff and Mantega were making excuses and picking fights by decrying the inflow of dollars into Brazil after 2008. They were, a little. But they were also right that Brazil was suffering due to the flood of foreign capital, and Brazil is now suffering at the way things have changed directions so rapidly.

Unfortunately, given the state of the international economic and monetary system, there’s little emerging market countries can easily do to avoid huge swings in the value of their currencies. The dollar is the international reserve currency, and the vast majority of Brazil’s trade is conducted in dollars, too. Some hope for a world in which neither of these things is true, and the US stops dominating global monetary conditions, but that is a long way off. In the mean time, one can only watch the Fed, or take comfort that the US may not be able to dominate forever if it keeps shutting down its own government.

Guido Mantega – Taking heat. In the last 3-4 days, international opinion on the Brazilian economy has turned.

It all started last week, when Guido Mantega, Brazil’s Finance Minister, predicted the beginning of a turnaround in the country’s economy. Then the actual third quarter results came out, far below what he, and even the most pessimistic economists, had predicted.

This has set off a wave of doubt, head-scratching, and criticism, especially abroad. It’s a significant moment, as people are beginning to really question what is going on here, where there had recently been almost miracular economic growth.

As always, I think the propensity of those of us in the media is to exaggerate and then indeed exacerbate short-term swings in economic cycles (we as probably did on the way up in 2010). Unfortunately (we) foreign correspondents can actually matter on these kinds of issues, affecting investment flows. So this conversation is an event in itself.

For the record, I think Brazil’s long-term fundamentals are still very strong, a rebound will come, and that some of the current problems are over-stated, specifically the worries that the state is becoming dangerously interventionist or that rules and contracts here aren’t clear. That criticism to me seems ideological – if China and Korea are allowed to be so different from the US or the UK, why can’t Brazil do things their own way? There are more ways than one to run an economy. The state plays a big role here, and it has been that way for a long time. Dilma has changed very little. Let’s not forget another little fact: during this period of stagnation, no is one losing jobs and wages have continued to rise. But since this isn’t about me, let’s let them talk:

Washington Post – Amid slowdown, Brazil turns inward – Echoes Washington’s accusations of protectionism

Reuters – A case study in Brazil’s economic troubles – a company hurt by Dilma’s move to lower the price of electricity

Nomura – Brazil, the confidence paradox (PDF) – The most in-depth and, for my money, the best analysis. Says – the Brazilian government is solving the right problems, but in ways that make international investors uncomfortable. Is it worth it?

Reuters – Brazil’s economy, five strengths and weaknesses – Right on the money about high costs, and on how we haven’t yet seen the (significant, positive) effects of lower interest rates

Financial Times – Beware membership of this elite club – This one may hurt the most. Argues that it’s a very bad time to be a BRIC

Financial Times – Downturn shakes Brazil from its dream – A good overview. What is going on? What can be done?

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Guido Mantega, Brazil’s powerful finance minister, said this week that global economic growth will slow in 2012, leading to an intensification of the destructive “currency war”.

Does this mean that we may see more government intervention in the Brazilian exchange rate, or simply that Brazil has not tired of dishing out acerbic critiques of the US and Europe?

Mantega famously coined the term, “currency war”, in late 2010 to describe a change after the 2008 crisis, in which countries were fighting to weaken their currencies against each other. Since of course this is not possible for everyone, international cooperation breaks down and ominously, countries end up battling each other with policy instruments.

Basically, he was talking about the following:

After the crisis tore through the rich countries in 2008, they slashed their interest rates to zero, passed large stimulus packages, and then ended up turning to quantitative easing – essentially printing money – in an attempt to further boost the economy.

The flip-side of this is that a large amount of the capital previously invested in those countries was moved to countries like Brazil, where there was essentially no crisis, and rates of growth and interest were much higher. These huge inflows caused the Brazilian real to appreciate greatly, causing many to worry that the high cost of Brazilian exports would kill off manufacturing, or “de-industrialize” the country.

Mantega has been especially critical of quantitative easing in the US.

“It’s no use throwing dollars out of a helicopter,” he said in late 2010. “The only result is to devalue the dollar to achieve greater competitiveness on international markets.”

Brazil retaliated by intervening in currency markets and introducing a set of capital controls, making it more difficult and expensive to move money in and out of the country, putatively slowing down appreciation while certainly infuriating many international investors.

But since then the situation has complicated. Mantega made his recent remarks, the Wall Street Journal reported, at a meeting of finance ministers in Mexico City. These days, worries about the potential collapse of Europe are more predominant than currency concerns. The effect of that crisis has largely been to bring the Brazilian real back down somewhat, as global panic usually means a flow of investment into safe currencies like the dollar.

Mantega is no doubt right that this year could be a rocky one for the global economy. That this could lead to more effective devaluations in the US and Europe is quite possible, which could surely lead people like Mantega to take counter-actions.

Let’s hope he was warning against the possibility of intensification, rather than accurately predicting the future. Historically, competitive devaluations have not served us well.

Links

Story from the WSJ

FT: Mantega attacks QE 

LA Times: worries about “de-industrialization”

Wikipedia – A surprisingly hefty entry built around Mantega

Photo above – Mantega with IMF Chief Christine Lagarde

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