Throwing Lots of Money at Brazil Simply Won't Help
International Herald Tribune
September 21, 1998
Charles Wyplosz

Under pressure from the United States, the Group of Seven leading industrial nations is again ready to throw huge amounts of emergency money at Brazil.

The argument is becoming all too familiar. Badly hurt by weeks of frantic defense of its exchange rate, Brazil is about to default on its external debt. This could damage the re-election prospects of President Fernando Henrique Cardoso, a very able president and friend of the United States. If Brazil goes down, Argentina would soon follow. When the two regional giants are hit, no Latin American country will be spared the contagion.

More than $100 billion dollars was sent to Asia last year. Yet, the contagion spread. All governments in place before the crisis hit have been swept away, except for that of Prime Minister Mahathir bin Mohamad, who has recently taken Malaysia on an anti-market and anti-West course.

The emergency package to Russia, last July, has not prevented the collapse of the ruble. President Boris Yeltsin has lost his grip on power. All the same, the G-7 will keep bankrolling the newRussian leadership, which is already busy fueling hyperinflation and destroying the few market institutions thatthe greedy reformers created early on.

Emergency money from the G-7 systematically misses its purpose; it only fills up corrupt pockets and bails out Western lenders and financial institutions. Who pays? Not the Western taxpayers, since these are just loans, but the citizens of the G-7's favorite charities, who must cough up debt service.

The G-7 keeps repeating the same basic mistakes. The first is the belief that crises can be stopped by massive cash injections. The International Monetary Fund typically looks at how much of a country's external debt is coming due over the next few weeks and provides the cash to bridge the gap.

Facts have repeatedly proven this calculation to be wrong, for good reason. When a crisis is under way, external debt service is like froth on a tidal wave. Any dollar that reaches the country is immediately bought up in a frenzy of genuine panic and deft speculation. Pouring in more money is like filling up a cracked barrel, with no limit in sight.

The second mistake is classic. Many countries peg their exchange rates to achieve low inflation and establish the respectability that comes with a strong currency. This works well for a while, but only very similar countries can tie their currencies together for a long period. Even like-minded Italy, Britain and Sweden were forced out of the Deutsche mark peg in 1992.

The Asian countries are just too different from the United States. Canada, like Russia an exporter of natural resources, has always allowed its currency to float. Mexico loosened public finances during the 1994 election campaign, sealing the fate of the peso-dollar link. The same is happening in Brazil, and the outcome is written on the wall.

The defense of a doomed exchange peg becomes the eye of the storm, calling upon itself the immense forces of speculation. And yet the IMF, which sets tough conditions for the G-7 rescue packages, repeatedly omits to require that the currency be set free.

The last mistake is the naïve belief that open financial markets are good for all countries. It is in the nature of financial markets to display occasional herd behavior. In the United States and Europe, it has taken decades — and many crises — to build financial institutions resilient enough to weather periods of panic. When emerging markets with weak institutions link up with the world financial markets, they open wide the channels of contagion that now spread like a modern plague. Yet, the dogma of unfettered laissez-faire retains devout zealots in Washington and Frankfurt, giving markets a bad name all over the world. What is to be done?

First remove the exchange rate peg in Brazil, Argentina and Chile, among other countries. Will this trigger a run on the currencies? Probably, but a run is in the making anyway. Better get it over with before a few more billions are added to external debts.

Second, declare a moratorium on external debt and encourage Western creditor banks to do what banks always do to help their best customers in temporary trouble — provide more loans.

The world is craving for G-7 leadership in reforming the international monetary system, but there is no need of IMF or G-7 money. Of course, reform is much harder than generously throwing money at the expense of taxpayers in poorer counties.

The writer is a professor of economics at the Graduate Institute of International Studies in Geneva and a research fellow of the Center for Economic Policy Research in London. He contributed this comment to the International Herald Tribune.

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