Brazil and the Euro - Part 4

Brazil and the Euro - Part lV - Published in October 2001

“Adoption of the Euro is the only solution to fix the Brazilian economy.”

Today, the adoption of the Euro by Brazil has become a critical issue and one of the few options available to save the Brazilian economy from further decline.
By: Ricardo C. Amaral

In the last two years I have written many articles recommending that Brazil adopt the Euro as the new Brazilian currency. Today, the adoption of the Euro by Brazil has become a critical issue and one of the few options available to save the Brazilian economy from further decline.

Today, we might be heading to a new world wide Great Depression as in the 1930's. Japan's economy may already be in a depression. The Japanese banking system is in deep trouble and things will get only worse for them in the near future. China had over 200 million people unemployed at the end of 2000, and the Chinese government is having a terrible time with a growing unemployment problem as people surged into cities and towns in search of work. China's unemployment will rise even further as a result of this new economic depression and the World Trade Center tragedy of September 11, 2001.

This tragedy will affect the economies of all economic trading partners of the United States, including Japan and China. Another economy that is in deep trouble today, is the economy of Argentina. Since Argentina is a major trading partner of Brazil, this Argentinean economic decline, will have an adverse and negative impact on the Brazilian economy.

In the last twelve months the current Brazilian currency, the Real, lost another 53 % of its value against the US dollar. The Brazilian currency which was trading at US $ 1.00 = R$ 1.85, in October 2000, reached a new low versus the US dollar on September 21, 2001 when the exchange rate was at US $ 1.00 = R$ 2.82.

On January 31, 1996 the exchange rate was US $ 1.00 = R$ .95, and since then the Brazilian currency lost 66 % of its value against the US dollar. That means that if you had invested US $ 1.00 five years ago in Brazil, that US $ 1.00 would be worth only US $ .34¢ today, and you would have lost 2/3 of the value of your investment in terms of dollars. This type of performance is completely unacceptable. What is happening in Brazil is that the government is allowing the country to become poorer and decapitalized.

Why is the Brazilian economy shrinking?

The Brazilian economy is being decapitalized—every individual in Brazil is getting poorer by the day, including the country itself. All you need is a little common sense to realize that the Brazilian economy is being decapitalized and its currency is being debased. The Brazilian gross domestic product (GDP) was US $ 1 trillion dollars for the year 1998, compared with the current (GDP) of US $ 500 billion dollars. In terms of the US dollar the Brazilian economy lost half of its value since the end of 1998. When a country allows its currency to become debased the result is that you will have a debased economy as well.

Why should anyone invest in Brazil?

What justification does anybody have to invest in Brazil today? Why should anyone in his right mind invest a dime in Brazil— unless you are willing to lose the money you are investing?

In the first article of this series published in the July 1999 issue of "The Brasilians" I wrote the following: "Today the amount of money that international speculators have under their management is becoming mind boggling. The amount of daily currency transactions in global markets is over $ 1.5 trillion dollars. The magnitude of daily currency transactions is a major contributing factor for many countries losing their capacity to defend their weak currencies from the foreign attack of these international money speculators.

These countries don't have the economic reserves necessary to defend their currencies from foreign speculative attacks. It is getting easier for these international speculators to destroy the entire economy of countries such as Russia, Indonesia, Malaysia, Thailand, South Korea, and Brazil. All they have to do is destroy their currency and the economies undergo a complete collapse. It is a form of modern economic warfare."

A weak Real is affecting even the fortunes of billionaires.

As we can see by the table below, even billionaires are affected by this currency and economic debasement of the Brazilian economy. Based on Forbes Magazine's annual list of billionaires, which is published on the first week of July of each year, the following is the ranking and the estimated net worth of Mr. Roberto Marinho, a Brazilian businessman who made the list the last two years:

Name.…………….......…….Date…………………………...Rank…..…NetWorth………. …………………………………….......................................……………(US$bil.)…

Roberto Marinho….(as of July 3, 2000)………………….42………………6.4

Roberto Marinho….(as of July 9, 2001)…………………336……………...1.5

The major culprit for this decrease in wealth is the weak currency—the Real. This unsound currency undermines the entire economy of Brazil including the economic activities of such companies as TV Globo Network (Mr. Roberto Marinho is the owner of this communications empire in Brazil which includes the major television network in Latin America, cable TV, radio stations, and one of the major publishing companies in Brazil—also including a major newspaper and magazines). Because of the combination of a falling currency (the Brazilian Real), and a television and newspaper advertising slump during the year 2001, it is very possible that Mr. Roberto Marinho will not make next year's Forbes list of billionaires.

Should Brazil adopt the Euro as its new currency?

Let's see what Brazil's options are in this matter. On one hand Brazil can adopt the euro as its new currency and 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.

On the other hand Brazil can continue to live in the world of illusion and keep its current currency the Real and think that this is a way to keep intact its sovereignty as a country.

I don't know why the people running the government in Brazil think that by keeping a currency, such as the Real, that means that they are keeping the country's sovereignty intact, when the truth is that this little currency by international standards is the source of the debasement of the Brazilian economy.

The old adage says that there are only two things that are certain in life; taxes and death. We can add one more item to this list; that the currency in Brazil (Real) will lose its value in relation to the other major currencies of the world. Why make an investment in Brazil with its shrinking value of the Real unless you are willing to lose your investment over a period of time? How poor do the Brazilian people have to become, before the Brazilian government realizes that they have no other option than to adopt the euro as its new currency?

Today, if you want to invest in Brazil, just wait a little longer and you will be able to pick up the bargains left behind after the wreckage of the Brazilian economy. How many sound Brazilian companies have to get in financial trouble because of the very weak Brazilian currency, before the government realizes that the Brazilian economy it will be in much better shape if Brazil adopts the euro as its new currency.

Brazilians don't trust their Brazilian currency.

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.

Why Brazil should adopt the euro as its new currency.

Abandoning a weak national currency such as the Real in favor of a stronger international currency as the euro 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 Brazil to take out long-term loans.

The adoption of the euro by Brazil would bring about safety and stability 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.

It is worthwhile to repeat again a portion of my article that was published last year, because of what has been happening to the Brazilian Real in the last 12 months. 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 do 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."

Damage to the Brazilian economy.

The damage to the Brazilian economy is worse than people first realized. The government keeps wasting good monetary reserves to keep this moribund currency barely alive. At the same time the government is selling the government's companies (which is part of the nation's patrimony) to raise money to burn in the lost cause of defending the weak Real.

The other major loss to Brazil is the human capital loss. There are a large number of well educated Brazilians who are moving out of Brazil in their search for a better future (according to Veja magazine July 18, 2001, over 2 million Brazilians live outside Brazil). Many Brazilians unhappy with the economic situation in Brazil, are moving to foreign lands, and in many cases these are the people with better education and skills. They cause a big drain in the pool of skilled workers left in Brazil. This outflow of human capital will have a negative long-term impact on the future economy of the country.

International Monetary Reserves.

Below is a table with the international monetary reserves of select countries as of December 31, 1998. As you can see it is not a good idea to create a new currency for South America. We can estimate that as of December 31, 2001 the monetary reserves for the countries of South America should be much lower than three years ago.

How can the Brazilian government even dream of defending the Real in the long run with such a small amount of monetary reserves? On the other hand the Euro area group of countries have a substantial amount of monetary reserves to keep the euro stable over the long haul. Long-term stability is the name of this game.

………………………………International Monetary Reserves…………………
…………………………………...As of December 31, 1998…………………………
…………………………………………( U.S. $ millions )………………………………
World select areas……………………………………………………………………… …………………………...………….....…..…Reserve………….…Foreign…………
………….....…...Gold……....SDR's………Position……………Exchange…….TOTAL
…………………………………………...….....in IMF……

Euro area……...98,033……..5,529………….25,688………………281,538…….410,788

South America*...6,053……….753……………1,710………………115,781…...…124,297

Japan…………1,194……...2,663……………9,593………………203,215….....216,665

China………….624……..…..676……………3,553………………144,959…......149,812

Brazil*………..1,358………..…..2………………...0……………....42,478….....….43,938

Note: Brazil figures included on total for South America.

Why will the Euro 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 of political control from its members.

This way of operating keeps the politicians out of the decision-making 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.

The euro countries today have international monetary reserves valued at over US $ 411 billion dollars. They also have a population estimated at 320 million people and a gross domestic product (GDP) of US $ 7 trillion dollars. After Norway, Sweden, Denmark and the U.K. also adopt the euro, the total euro area international monetary reserves will increase to over US $ 500 billion dollars and the total population will be around 400 million people, and the GDP should increase by another US $ 1 trillion dollars.

Brazil will be better of as a nation under the euro currency.

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.

Euro the best option for Brazil.

The fact that I have been advocating in my writings that Brazil should adopt the euro as its new currency, has nothing to do with being anti-American. It has to do only with what is best economically from the Brazilian point of view.

It makes more sense economically for Brazil to adopt the euro instead of the American dollar. The Brazilian economy matches much better with the various economies that make up the European Union than the economy of the United States.

I am saying that from a practical point of view after being a controller for various Brazilian companies in the United States in the last 16 years. When I worked for these international trading companies, we had a terrible time finding any products in Brazil that we could sell in the American market. We couldn't compete with the United States in almost anything. The US economy is too far advanced in terms of technology and quality of its products, and because of that the Brazilian companies did not have a fighting chance to enter and compete in the United States market.

The Brazilian companies in general have a better chance to sell their products in the European markets. This is why trading between Brazil and Europe has been expanding very fast in the last 15 years and trading with the United States has been flat. Sure, there are other reasons as well that contribute to that, including the understanding that Europeans have of Brazil and the cultural ties.

The Brazilian economy will be in better shape in the future if Brazil adopts the euro and the Brazilian economy integrates with the Euroland economy. Brazil and Brazilians will become better off under the Euro system than if Brazil tries to continue with its own currency. If Brazil continues on its current path and doesn't fix this currency problem the end result might be a revolution in Brazil, and a possible return to a military dictatorship.

Part lV of this series- originally published by

"The Brasilians,” issue number 317, pg. 4E, October 2001.

Copyright © 2001 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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