It started out with good news. When Brazil floated the real on a Friday, the initial drop in the currency was moderate, and the stock market soared on hopes that the grim austerity program would soon be loosened up. Then Brazilian officials went to Washington; and over the weekend they were persuaded - bullied, according to rumor - into announcing that interest rates would be raised, not lowered. The result was despondency, and a collapse in the currency.
I do not understand why Washington was unwilling to give floating a chance. One might almost suspect that they were afraid to see Jeffrey Sachs proved right. If Brazil could successfully let its currency go, without raising interest rates, that meant that the recession being imposed on Brazil - and perhaps the recessions imposed elsewhere - had been unnecessary, gratuitously imposed on behalf of an incorrect theory. It cannot have been a pleasant thought.
I have carefully avoided saying anything publicly about the Brazilian implosion - largely because things started out so well, and I kept hoping that the initial favorable results could somehow be recaptured. It was not my place to say anything fatuously optimistic - that is a job for public officials - but I did not want to be one of those feeding the panic, or gloating that my doubts about the IMF program had been vindicated.
It is hard to see now, however, how saying the obvious can make things any worse. Investment newsletters are warning about debt default and hyperinflation, forecasters are predicting an Asian-level contraction in output, and there are even some lines at banks. And the latest rumors - which I can only hope are false - say that the IMF, incredibly, wants Brazil to raise interest rates yet again.
President Cardoso has said that capital controls must not be considered, because to impose them would be to give up any chance that Brazil will become a "first-class" nation. One can only sympathize with his plight: he has tried so hard to do the right things, and received so little reward. But a debt default, a return to inflation, or a catastrophic recession will do far more to set Brazil back than a temporary curfew on capital flight; and those are starting to look like the alternatives. Remember that many of the world's "first-rate" nations had capital controls for a generation or more after World War II; to need them now is a shame, but not shameful.
The principle of free speech does not include the act of shouting "Fire!" in a crowded theater; the principle of free markets should not include doing nothing when investors are trampling each other, not to mention a national economy, in a stampede for the exits. For that is what is now happening. Investing in Brazil would be safe and profitable were it not for the risk of crisis; which is to say that the individual investor is not so much afraid of what the government might do as of what other investors might do. If each investor had believed that the others would stay calm, everything would be manageable; but investors mistrusted each other - and the crisis came.
As it now stands, capital is fleeing Brazil because of fears that the government will be unable to service its debt because of soaring interest rates, a plunging real, and an economic slump; and interest rates are soaring, the real is plunging, and the economy is slumping because capital is fleeing. It is a case of almost perfectly circular logic, and the circle is vicious.
By rights, Brazil ought to be able to stabilize the real well above its current level, without a financial meltdown. Unlike Asian countries, its companies are not heavily burdened with dollar debt; that is why it seemed so plausible, on that first day, that freeing the real could turn out to be just what Brazil needed. The objective now should be to turn the clock back to where it was on January 15, and start over. To do that, however, Brazil must first stop the panic.
I would be happy to be proved wrong about this, but I do not believe that at this point mere verbal appeals for calm, announcements of new inflation targets, additional fiscal moves, even the introduction of a currency board (for which Brazil does not in any case have the resources) will do what is necessary. If they are not, a temporary imposition of exchange controls would be in everyone's interest, including that of the investors themselves.
One thing seems certain: the high-interest-rate cure is utterly wrong in this case. The IMF now likes to claim that the stabilization of Asia, and the beginnings of some recovery in Korea, prove that this approach works; this is like the highway safety department claiming success because most accident victims survive, and some eventually learn to walk again. Whatever Brazil does next, please let it not include yet another increase in interest rates.