With all the talk of China (4 panels) I finally got to hear about Brazil. And the word on Brazil is inflation. I know this is shocking news but, folks, Brazil’s success has not been entirely based on economic liberalization. Let’s put this in perspective. The main driver of economic growth has been exports: iron ore, gold, oil, and food (soybeans). One of the main markets for Brazil has been that other developing giant, China. Private money, it was noted, is building a huge port system to deliver ore to China. The whole infrastructure is being created: port, shipping, and ore. One wonders what would happen to these feeder countries if China goes into recession or worse.
This has been good for the average guy because their unemployment rate, assuming these are good statistics, is about 6%. For the first time ever credit is being extended to the middle-class. And this is driving consumption. The problem is that they are having price inflation, about 6.3% according to the panelists.
The government is aware of the issue. On the one hand credit expansion to new classes of workers who now have a steady paycheck is threatening the economy and the government is acutely aware of it. If they kill inflation, they are afraid they will kill the aspiring middle class.
The panelists, I should mention, were from a large internationally recognized investment companies. One was a former central banker. The title of this piece is not an exaggeration: their explanations of economic phenomena were the conventional wisdom. They do understand the role of the central bank in inflation, but more on the level of what the central bank can do to stop it. They also discussed the fact that Brazil’s central bank had an inflation target (think of the Taylor Rule) and that was a good thing as well. In other words they have a technocratic view of economics in which the great tinkerer (in our case Ben Bernanke) can fine tune the Brazilian economy with such targets. After all everyone knows that some inflation is a good thing.
The consensus was that Brazil will engineer a gradual reduction in inflation and have the perfect “soft landing.” Those ideas are what you get when you spend too much time talking to a central banker. One panelist predicted that interest rates will rise gradually and they will within 2 years reduce inflation from 6.3% to 4.5%. As a consequence GDP will slow from 6% to 4% and perhaps under 3% for a brief interlude.
The Taylor Rule target will cause inflation to peak by September of this year and then subside. The former central banker said that the problem was inflation expectations and before the inflation rate declines, union contracts will be negotiated and keep prices high. Unions may demand indexed contracts which, he noted, would really make it difficult to slow price inflation. My comment is that if it were that easy, just lowering expectations, then see what happens if they keep credit flowing after they lower expectations. In order to stop price inflation you need to stop inflation, which all readers know if the printing of money by the central bank.
One panelist recommended that the government spend less. Right now their debt is 5% of GDP. Any more, she said, they will “crowd out” private capital from the market. As you know Brazil now has some capital controls which is making it more difficult to import capital, i.e., make it more difficult for investors to enter the market.
It sounds as if Brazil will be in for a bit of rough ride. Politics trumps all and my guess they will continue to inflate as long as the people are happy. What that point is, should be addressed by someone on the ground, not me.