Although the dramatic rebound in the U.S. stock market has allowed us to forget about the rest of the world for a while, the fate of the global economy over the next year or so still hinges, precariously, on what happens to Brazil. And recent news from there has not been good.
The IMF has put together, as expected, a $30 billion package intended to help Brazil meet its current debt payments, prop up its currency, and improve its standing in foreign credit markets. In order to get that package, Brazil's president promised to push through an austerity budget designed to bring down the country's deficit, which now totals 8% of GDP and which has been financed in part by foreign creditors. The budget, which purported to cut spending and raise taxes, is not exactly the ideal fiscal solution to an economy that now appears to be entering recession, but Brazil's already sky-high interest rates--which have been in the 40% range for months now--have left the government with few options if it wants to prevent capital flight, pay off its debt, and prevent a sharp rise in inflation. And the budget that Brazil has now offered does not really live up to promises. Spending actually increases, and the tax increases are not as rigorous as we might have hoped.
To a certain extent, as I've argued here before, Brazil has made the bed in which it now finds itself sleeping. Its public sector comes straight out of Ronald Reagan's nightmares, as an article in today's New York Times makes clear. (Even now, as pensioners and unemployed workers are preparing to feel the bite of budget cuts, civil servants and government officials are buying Persian rugs, enjoying salary bonuses, and supplementing their salaries with exorbitant per diems.) Although President Cardoso did a great job in rescuing the economy from hyper-inflation, he never shifted the focus of public policy from interest-group squabbling over the existing pie to the kinds of investment that would make the pie grow bigger. And the Brazilian appetite for foreign goods--fueled by an overvalued currency--helped create the current-account deficit that now exists.
Still, the way global markets have punished Brazil is out of all proportion to what the country did wrong. (If budget deficits and current-account deficits were reason enough to be thrust into recession, the U.S. economy wouldn't have grown an iota over the last two decades.) The elimination of risk tolerance on the part of foreign investors indiscriminately swept across the developing world, and Brazil has felt the brunt of that. Brazil's problems, whatever they are, are not new. It's the market's reaction to them that is.
What's scary about what's happening now is that although Brazil really is, in some sense, too big for us to allow it to fail, nothing that either the international political community or the international financial community has done is substantive enough to guarantee that Brazil's markets won't fall apart. Large U.S. banks, in fact, now appear to be anticipating a Brazilian devaluation, which will send emerging markets around the world into a tailspin. They've cut back on their exposure to Brazil (although it remains substantial), and they have not stepped up to the plate with promises of further assistance in the wake of the IMF package. That package, meanwhile, was an important symbolic gesture. But Brazil has $150 billion in short-term debt coming due over the next eight months. How much help is a $30 billion credit line really going to be?
In other words, we've decided that all we can do is sit and hope. If currency speculators decide to make a run at the real, and if capital flight begins again (the country's capital flows are currently neutral), then it'll be pretty much up to chance whether or not Brazil weathers the storm. It's comforting to believe that markets are always efficient. But at this point, it's hard even to figure out what "efficiency" actually means.