Brazil and the Euro - Part 2

Brazil and the Euro Part II – Published in November 1999

“How can currency stability be achieved for the Brazilian economy?”

The short-term sacrifices required by the Brazilian people to meet the euro’s requirements will be rewarded in a big way in the future -- with monetary stability, lower interest rates, a sound economic environment for investments, and access to European money markets.

By: Ricardo C. Amaral

The original article was published by "The Brasilians" issue # 295, July 1999, page # 4E. The current article is in response to letters received by the editor regarding that article.

Out of the 15 countries which comprise the European Union (EU), 11 countries also belong to the new European Monetary Union (EMU). The (EMU) country members adopted the new currency -- the euro, as of January 1, 1999.

The resulting euro market created an economy with more than US $ 6 trillion in gross domestic product (GDP). If Brazil becomes a member of the European Monetary Union (EMU) the Brazilian economy would add another 15 % to the size of the (EMU); an increase of (GDP) to US $ 7 trillion.

There are some (EMU) criteria established by the Maastricht Treaty which countries wishing to join the (EMU) are required to meet before they are allowed to join the euro group. The criteria are as follows:

• Their inflation rate should be within 1.5 percentage points of the three best performing (EMU) countries.

• Their exchange rate should be stable in relation to the "Euro".

• Their government debt must be less than 60 % of gross domestic product (GDP).

• Their government budget deficit must be below 3 % of their (GDP).

Four countries that are members of the European Union (EU) -- England, Sweden, Denmark and Greece, are not members of the (EMU). Greece wanted to be a charter member of the (EMU), but they did not meet the economic criteria for membership. The other three countries decided to wait and see how the euro system experiment actually works before they decide to become a member of this new system. It is just a matter of time for them to join the club.

Can Brazil qualify for euro membership?

In January 1999 the Brazilian Government budget deficit was around 8.5 % of (GDP). To qualify as a member of the new euro club, Brazil would need to bring its budget deficit to the 3 % benchmark.

The short-term sacrifices required by the Brazilian people to meet these requirements will be rewarded in a big way in the future -- with monetary stability, lower interest rates, a sound economic environment for investments, and access to European money markets.

Why do Brazilians have over US $ 150 billion dollars invested outside Brazil? Because they are not fools, and they don't trust the country's currency -- such as the Cruzeiro, the Cruzado, the Real or any new weak currency they might adopt in the future.

If Brazilians don't trust their own currency, how can we expect people from other countries to have any trust in the soundness of the Brazilian currency? If you are a Brazilian, you know that to protect your assets you have to transfer them out of Brazil to a safer and more stable economic environment, such as the major countries of the European Union or the United States.

The adoption of the euro by Brazil would stop this Brazilian capital flight and would provide a sound economic environment in Brazil, with a sound and stable currency which Brazilians can trust; then Brazilians would be able to bring back home the US $ 150 billion dollars invested in foreign lands.

If you want a more detailed explanation of the reasons why Brazil should adopt the euro as soon as possible, you can read in the Fall 1999 issue of "Foreign Policy" the following article written by Mr. Ricardo Hausmann, chief economist of the Inter-American Development Bank, "Should There be Five Currencies or One Hundred and Five ?"

What floating currencies mean to Latin American countries?

Some highlights from Mr. Hausmann's article follow. He said, "A recent study by the Inter-American Development Bank suggests that Latin American countries with floating currencies end up with financial systems that are 15 to 30 percent smaller than they otherwise would have been. One reason is that letting the exchange rate appreciate in good times and depreciate in bad times reduces the incentive of residents to hold their assets in the domestic currency because it does not help diversify the income risk they already bear. In good times, when incomes are high and people are in a position to save, the value of their previously accumulated savings goes up through currency appreciation. In bad times, when income is low and people might wish to dip into their savings, they find their assets are worth increasingly less because of currency depreciation. Hence, residents of these emerging-market countries will want to hedge their savings by moving them out of the domestic currency."

Mr. Hausmann's article describes how "floating exchange rates in Latin America has increased the volatility of domestic interest rates, making banking a riskier industry. Floating can entail huge costs. It could be the catalyst for a shrinking financial system, as residents move their assets out of the domestic currency. It can cause domestic savings to flee, leaving countries with fewer resources to finance growth. In addition, highly volatile domestic interest rates will make banking riskier and will conspire against the development of long-term markets."

Mr. Hausmann's article also describes how "abandoning a weak national currency in favor of a stronger international or supranational currency would eliminate currency and maturity mismatches, because debts would be denominated in the same unit as a company's cash flow. It would also allow countries to take out long-term loans."

The adoption of a supranational currency such as the euro by Brazil would bring the following benefits, according to Mr. Hausmann's article: "supranational currencies would be more stable and safer for capital mobility. Long-term interest rates would decline and become less volatile -- as we have seen in Europe, where interest rates have gone down in Ireland, Italy, Portugal and Spain -- making it easier to cut budget deficits and promote growth."

Why did England and Sweden stay out of the new euro system?

Sweden took a conservative position to first see how the euro system works in practice before they decide to become a member of that system. England also took the same conservative position, but in the case of England it is hard for them to give up their national currency because of national pride after being a world power. England was the major world power until 1918, and the Pound Sterling was the major currency in the world during England's reign as king of the hill. It is hard to let go of the past.

Today, England is not even the most influential country in the European Union, and it will soon realize it is time to move forward into the future, and it will adopt the euro as its new currency, leaving the history books to remind them of their past as a world power and of the glory days of the Pound Sterling.

What happened to the value of the euro in relation to the US dollar?

The euro was born January 1, 1999 at an exchange rate of US $ 1.17 to $ 1.00 euro. The expectation of the creation of the new currency in Europe in the fall of 1998, helped the euro currencies to increase in value in the last six months of 1998. When the euro born on January 1, 1999, that currency was overvalued by an estimated 9 percentage points in relation to the US dollar.

The euro just adjusted itself in relation to the US dollar from January 1, 1999 rate of US$ 1.17 to the current rate as of October 22, 1999 of US$ 1.067. The current rate reflects the current economic realities behind the two currencies. I have no doubt that the euro is here to stay, and it will become a major competitor to the US dollar in the international financial arena.

A final question raised by my article was regarding the geographic location, and the assumption that the euro was created to be adopted only by European countries.

With today's technologies in computers, communications, satellites, air travel, etc, distance is not an issue to stop any country from adopting the euro as its new currency. In that regard I want to remind the readers that Brazil and the United States operated for centuries with the currency of European countries. Brazil was a Portuguese colony until 1822 and the United States was a British colony until 1776, and before independence these countries operated with the currency of these European countries. The world has changed a lot since then. Country currencies used to be backed by gold or silver reserves; in comparison, today what do we have backing up the US dollar?

How about the future value of the US dollar in relation to the euro?

Today, the fortune of countries can change very fast. As we look around the world we can see what happened to the Soviet Union, Malaysia, Indonesia, Thailand, and Brazil, just to give a few examples of countries with weak currencies. A strong currency such as the euro implies that the governments behind that currency will protect the value of the currency, in turn creating a safe environment for investments to flourish and grow.

Yesterday, the Pound Sterling was king, but today England is reevaluating its options and in the near future the Pound Sterling will be history. Today the US dollar is king, but in the coming years the US dollar also will lose its appeal as the world changes and new competitors including the euro challenges the US dollar in the international financial arena. The reality check for the US economy and the value of the US dollar in relation to its competitors is around the corner with the expenses related to an aging population compounded by the weight of the US $ 7 trillion dollars of cumulative US government debt.

The United States has a cumulative federal government debt of US$ 5.5 trillion dollars plus other borrowings from various funds including the following amounts as of July 1999: Social Security US$ 845 billion dollars, Medicare US$ 148 billion dollars, Military Retirement US$ 140 billion dollars, Civilian Retirement Fund US$ 490 billion dollars, Unemployment Compensation US$ 81 billion dollars, Highway Fund US$ 35 billion dollars, Airports Fund US$ 15 billion dollars, Railroad Retirement Fund US$ 21 billion dollars, all others US$ 58 billion dollars, for a total adjusted actual cumulative United States debt of US$ 7.3 trillion dollars.

Eventually, the US government debt will catch up with reality, and the value of the US dollar will be adjusted accordingly in relation to other major world currencies. This is why Brazil should adopt the euro instead of the US dollar currency.

Can we create a new currency for South America?

If the countries of South America including Brazil and Argentina decide to create a new currency for that block of countries to compete with the euro and the US dollar in world financial markets, I have a suggestion for a name that would be very appropriate for that new currency -- the "Bankrupt."

In January 1999, I sent a letter to the President of Brazil, Mr. Fernando Henrique Cardoso and also to the Minister of Finance of Brazil giving them in detail the reasons why they should put in place a plan for Brazil to adopt immediately the euro as its new currency. I also sent copy of that letter to the Brazilian ambassador in Washington, and faxed copies of the letter to the major Brazilian newspapers and magazines in Brazil.

People tell me that Greece has not qualified to become a member of the euro and how can I expect that Brazil would qualify? An article published in "The Economist" in the issue dated October 16th , 1999 "The euro's in-and-out club" (pg. 51) claims that Greece is on its way to meeting the criteria for euro membership, and aims now to join in January 2001.

A lesson in leadership and statesmanship from our Brazilian history.

At this point, it will be relevant to this article to quote from my book which is in the process of being published -- José Bonifácio de Andrada e Silva "The Greatest Man in Brazilian History" by Ricardo C. Amaral, Copyright © in December 1998, and to be published in December 1999.

In 1822, José Bonifácio de Andrada e Silva made many courageous decisions regarding our country Brazil, which assured us not only our independence from Portugal, but also kept our country from splitting into several parts. José Bonifácio's decisions projected a firm, decisive and powerful image of his administration also in his foreign policy. In his diplomatic letter to the American Consul in Rio de Janeiro P. Sartoris in which he appointed a diplomat to represent Brazil in the United States, José Bonifácio wrote " Dear Sir: Brazil is a nation and will take its place as such, without expecting or requesting its recognition by the other world powers. We will send them representatives of our nation. Those nations who receive and deal with them in that capacity will continue to be allowed to use our ports and their commerce will receive favorable status. The nations that refuse our diplomats will be excluded from our ports and commerce. This is our frank and firm politics." He also sent a similar letter to Chamberlain, the English representative in Brazil."

Today, this is the kind of political leadership we need in Brazil, to guide Brazil for membership in Euroland and create a more stable economic environment for our country, and start the new millennium on the right path for growth and prosperity.

The United States has a much stronger and powerful economy because it operates with one currency -- the US dollar. The economy of the United States would not be as strong if California, New York and Texas -- each had its own currency. We have in the United States different economies operating under a single currency -- Texas has its oil economy, California has its high tech economy, Nebraska has its agricultural economy, but they all operate reasonably well under a single currency, even though some times a change in the value of the US dollar would benefit the economy of one state and hurt the economy of another state at the same time.

Why the euro will provide macroeconomic stability for its members?

The members of the Executive Board of the European Central Bank (ECB) are not there to represent their countries of origin. They are there to provide stability to the euro and they look at Euroland as a whole when making their policy. The euro is a monetary arrangement, and its monetary policy will be adopted independent from political control from its members.

This way of operating keeps the politicians out of the decision process and reduces the risk of them playing their political games with the country's monetary and currency systems. I am a firm believer that if the economic policies adopted by the (ECB) are good enough for such a diversified group of countries as France, Belgium, Germany, Netherlands, and Italy, then such policies also will be good for Brazil. The Brazilian economy will be better off under the euro system than under the fragile and weak Brazilian currency.

On a final note, on Wednesday, October 13, 1999 the economist Robert A. Mundell of Columbia University in New York, won the Nobel Prize for Economic Sciences. Mr. Mundell's innovative analysis of exchange rates in the 1960's helped lay the groundwork which eventually inspired the creation of the euro.

Part ll of this series- originally published by

“The Brasilians,” issue number 298, pg. 8E, November 1999.

Copyright © 1999 All rights reserved.

By: Ricardo C. Amaral.

Author and Economist

brazilamaral@yahoo.com

This article was reprinted on “Brazzil” magazine in June 2003.

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