Another Keynesian Failure: Brazil

This article was published by The McAlvany Intelligence Advisor on Monday, March 28, 2016:  

Boiled down to its most crude elements, Keynesianism, according to Antony Mueller at the Mises Institute, is “the economic policy doctrine of growth by spending.” Since 2003, when the current political party in Brazil, first headed up by Lula and now by Dilma Rousseff, came to power, it installed it in spades. For a while it seemed to work: demand for Brazil’s raw materials: oil, iron ore, and agricultural products grew as China (also pursuing the “growth by spending” mantra) also grew.

But the boom, which at one point included Brazil as one of the BRIC (Russia, India, and China) nations that would soon overtake the developed world, went bust.Prices of commodities fell, cutting Brazil’s export income severely. Common sense economics would have demanded a cut in government spending, a reduction in taxes and regulations, all done with the deliberate intention of stimulating small business – the primary generator of jobs – to expand and offset the shrinkage in gross domestic product.

But no. Instead, Lula and now Rousseff are implementing more of the disease that caused the sickness: another $20 billion in government spending on public works projects to “stimulate” the economy. This makes as much sense as a homeowner whose wife was just laid off from her job to go out and buy a new car on credit.

The results are in. Last December Goldman Sachs said Brazil was officially in a depression: “What started as a recession [thanks to an] economy that accumulated large [debts] is now mutating into an outright economic depression, given the deep contraction of domestic demand.”

The latest numbers since then have confirmed Goldman: Consumers have cut back by more than eight percent across the board while investment spending has declined more than 10 percent last year, with cumulative capital spending down by 21 percent in the last two-and-one-half years. And there appears to be no end in sight. In Rio de Janeiro alone, the country’s largest city, 1200 small businesses have already closed thanks to rising costs and slowing sales. Unemployment is now at 16.5 percent, and the real, Brazil’s currency, has lost a quarter of its value against the dollar in just the last twelve months.

In February, Brazil’s private sector contracted to the lowest level since the composite output index published by Markit was developed in 2007. Mihir Kapadia, head of Sun Global Investments, a London investment firm that specializes in emerging market opportunities, said the Brazilian “situation has been made worse by high debt levels … [and] problems of governance, corruption, and political issues [that] have created a perfect storm….”

Someone has said that inflation is similar to a neutron bomb: it kills the people but leaves the buildings. In Brazil, inflation is leaving the people alive but increasingly destitute. The country’s external debt is approaching 200 percent of the country’s total productive output, forcing the government to borrow just to make its interest payments. This has reduced its sovereign debt to junk status by the credit rating agencies, and is rolling out into the private economy as well. Major companies have been forced into bankruptcy, including Brazil’s Grupo OAS conglomerate, which is selling off many of its assets as required by the bankruptcy court. Usiminas, one of Brazil’s major steel producers, failed to make interest payments on one of its debts, and Standard and Poor’s has declared the company to be in default.

The country has a labor force of 95 million, and 54 million of them are behind on their credit card payments. Brazil’s phone company lost $1.24 billion in the last quarter alone, and has seen its debt service triple in just the last year.

The National Bureau of Economic Research (NEBR) doesn’t define what a depression is, but various metrics provide a clue. A depression is characterized by abnormally large increases in unemployment (check), declines in the availability of credit (check), shrinking output as buyers stop buying and producers cut back (check), stalling of new investment capital (check), bankruptcies increasing (check), companies defaulting on their debts (check), and exports declining (check).

Two general rules apply when defining a sovereign bankruptcy: 1) real GDP declines by 10 percent (Brazil’s declined 3.8 percent last year and is expected to decline by a similar amount this year), or 2) a recession (quarterly declines in GDP) lasting two or more years (Brazil’s has declined for the last year and half).

Once the cleansing following Operation Car Wash has been completed, there is hope that the new administration won’t be slaves to the old, tired remedies that put Brazil in the can in the first place. As Mueller put it:

Brazil needs more than just a change of government. The country needs a change of mind. In order to get on to the path of prosperity, Brazil has to discard its prevalent economic ideology. Brazil has to get rid of its tradition of profligate government spending and easy money, Marxist-inspired state involvement in the economy….

Brazil needs a huge dosage of economic liberalization to find its way out of the current crisis. Less state intervention and much more freedom of doing business must be the first steps. For this to happen a change of mind is needed. Brazilians must open up to an alternative beyond state capitalism. Brazil must embrace laissez-faire in order to prosper.

This is the remedy, of course. But it can only be applied if enough of the citizenry recognize the disease.

Sources:

Mises.org: Brazil: Victim of Vulgar Keynesianism

The Guardian: Brazil’s economy slumps to 25-year low

The Wall Street Journal: Brazil Economic Woes Deepen Amid Political Crisis

Background on Brazil’s economy

CNN.money:  Brazil recession: ‘I’ve never seen anything like this’

Global Crisis: Goldman Sachs Says That Brazil Has Plunged Into ‘An Outright Depression’

The New American.com: Brazilian Government’s Unraveling Accelerates

Definition of a depression

David Stockman: The Brazilian Nightmare——-The Inexorable Toll Of Keynesian Central Banking

The Wall Street Journal: Brazil’s Grupo OAS Files for Bankruptcy Protection

Background on Usiminas Steel

Background on Rio de Janeiro