O' Grady on Brazil's response to QE2
WSJ's O'Grady on the pretense that the Fed is printing money to increase domestic demand as if money were not fungible. Via WSJ:
The Fed pretends that it is creating dollars in order to stimulate domestic demand. But the new reserves are unlikely to sit in U.S. banks waiting for a resurgence of U.S. growth. Instead they will pour into commodity markets. One place they are likely to end up is here, where a boom in oil, mining and agriculture today seems to spell opportunity.
Brazil's President-elect Dilma Rousseff may be pressured to respond to U.S. monetary easing with more protectionism and higher taxes.
As investors sell dollars and pile into the currencies of commodity-exporting nations, those monies appreciate. This is enriching for the locals, who earn, save and spend in this higher-value coin. But the shift in exchange rates also makes exports dearer for their trading partners. In trade talk this effect is commonly referred to as lowering competitiveness. Brazilian Finance Minister Guido Mantega may be famous for tagging the Fed's dollar blitz as the "currency wars," but the bank's actions are more aptly described as a trade war.
Over time, a country that devalues its own currency destroys its competitiveness because local producers face rising input costs and consumers lose purchasing power. But in the short run it is the trading partner that suffers as its products become less affordable in currency-depreciated markets. Chilean Economy Minister Juan Andres Fontaine recognized this last week when he noted that although the soaring price of copper in dollars is making the country richer, it is also pushing up the value of the peso and making Chile less competitive abroad. He urged local producers to "get cracking" to increase productivity and promised that the state would do its part to lower the official barriers to competitiveness.
Here in Brazil, it's hard to see how the real won't continue to strengthen in the near term. As the dollar price of Brazilian commodity exports heads north, more greenbacks will flow into the country, increasing the demand for the real and its price.
Brazil's central bank has been trying to prevent an appreciation of the real by accumulating dollar reserves and then shrinking domestic credit. But this process of "sterilization" is expensive. Yale-trained Brazilian economist Raul Velloso told me in an interview here that sterilization cost the government 1.4% of GDP in the past year, more than was spent on health care or infrastructure development.
Despite this, the real still rises. Brazil's commodity sector is world-class. But with a tax burden of 35% of GDP, onerous regulations and high trade barriers, manufacturers are already internationally uncompetitive. The Fed's launch of a trade war is likely to make things worse: Producers are bound to cry foul and demand that the government respond with subsidies and more protection.