Brazil’s Currency Crisis By Team IV ( Chris Trick, Austin Weaver, Tim Moore, Pat Heffernan, Chris Barnes Why Brazil MattersBiggest economy in Latin AmericaOne of the last big countries to attempt free trade and privatization; if this fails international investors discouraged.Unified global economy is threatened if Brazilian currency fails. HistoryBrazil had been through 6 currencies since the 1960’sIn 1994 the Real Plan was adoptedBefore it were a series of failed plans (the Cruzado Plan of 1986, Bresser plan of 1987, and more)It worked well to tame inflation and maintain exchange rate stability for 5 years HistoryThe Real was initially indexed one-for-one with the dollarIt was quickly allowed to float thoughA policy of high interest rates to discourage speculation and over-borrowing quickly attracted a surge of capital inflowsBy the mid 1995 the Real Plan evolved into a crawling peg HistorySaid to be the worst currency crisis in the western hemisphere to dateThe Real Plan was one of the longest running exchange rate stabilization programs Facts of Life Before Crisis43% of Brazilians – over sixty million people - lack the essentials of a decent lifeOne in three children drop out of school without completing primary Drug gangs rule the favelas and the middle class lives behind bolted doors Half a million North-eastern farmers watch crops wither in yet one more drought The urban environment, home to four out of five Brazilians, is deteriorating fast Blacks, over-represented amongst the poor, suffer social discrimination Indians face severe threats to their economic and cultural survivalThe income gap between men and women is the worst in Latin America Why Peg to Dollar?Needed to convince domestic and international investors that chronic inflation would be stopped.Before Real Plan, inflation was 3000%.Fixing the exchange rate was easier then reducing government commitments. The FallIt was in a financially fragile stateIt required large capital inflows to build up the central bank to defend currencyThis built investor confidence and led to exchange rate appreciationThis fueled import-driven consumption and stifles export growthIn order to attract the inflows the real interest rate had to rise The FallThe high interest rates lead to a rising debt burden and a deteriorating fiscal balanceA rising budget deficit and deteriorating trade balance inevitably lead to devaluationIt just could not finance its current account deficit due to insufficient long-term instruments The FallInvestors came to believe the capital inflows were insufficient to finance its current account deficitProductivity did grow from the imported capital goods The industrial restructuring it caused was not enough to fight off the deteriorating trade balance as unemployment rose The FallSpeculative pressure built up and it became harder and harder for the central bank to maintain the rateEventually the peg had to break; calling for a floating rat ...

1. Brazil’s Currency Crisis
By Team IV ( Chris Trick, Austin Weaver, Tim Moore, Pat
Heffernan, Chris Barnes
Why Brazil MattersBiggest economy in Latin AmericaOne of
the last big countries to attempt free trade and privatization; if
this fails international investors discouraged.Unified global
economy is threatened if Brazilian currency fails.
HistoryBrazil had been through 6 currencies since the 1960’sIn
1994 the Real Plan was adoptedBefore it were a series of failed
plans (the Cruzado Plan of 1986, Bresser plan of 1987, and
more)It worked well to tame inflation and maintain exchange
rate stability for 5 years
HistoryThe Real was initially indexed one-for-one with the
dollarIt was quickly allowed to float thoughA policy of high
interest rates to discourage speculation and over-borrowing
quickly attracted a surge of capital inflowsBy the mid 1995 the
Real Plan evolved into a crawling peg
HistorySaid to be the worst currency crisis in the western

2. hemisphere to dateThe Real Plan was one of the longest running
exchange rate stabilization programs
Facts of Life Before Crisis43% of Brazilians – over sixty
million people - lack the essentials of a decent lifeOne in three
children drop out of school without completing primary Drug
gangs rule the favelas and the middle class lives behind bolted
doors Half a million North-eastern farmers watch crops wither
in yet one more drought The urban environment, home to four
out of five Brazilians, is deteriorating fast Blacks, over-
represented amongst the poor, suffer social discrimination
Indians face severe threats to their economic and cultural
survivalThe income gap between men and women is the worst in
Latin America
Why Peg to Dollar?Needed to convince domestic and
international investors that chronic inflation would be
stopped.Before Real Plan, inflation was 3000%.Fixing the
exchange rate was easier then reducing government
commitments.
The FallIt was in a financially fragile stateIt required large
capital inflows to build up the central bank to defend
currencyThis built investor confidence and led to exchange rate
appreciationThis fueled import-driven consumption and stifles

3. export growthIn order to attract the inflows the real interest rate
had to rise
The FallThe high interest rates lead to a rising debt burden and
a deteriorating fiscal balanceA rising budget deficit and
deteriorating trade balance inevitably lead to devaluationIt just
could not finance its current account deficit due to insufficient
long-term instruments
The FallInvestors came to believe the capital inflows were
insufficient to finance its current account deficitProductivity
did grow from the imported capital goods The industrial
restructuring it caused was not enough to fight off the
deteriorating trade balance as unemployment rose
The FallSpeculative pressure built up and it became harder and
harder for the central bank to maintain the rateEventually the
peg had to break; calling for a floating rate.
Other ReasonsThe political power of the elite prevented tax
hikes and to encourage exports it could not impose higher taxes
on manufacturersThe public sector had won generous pensions
and benefits that the government could not afford any
longerDismantling these programs would have led to further
social instability

4. Other ReasonsGiven the political paralysis it is difficult to see
how the prolonged overvaluation of the currency could have
been avoided
How Much Was LostDuring the first 6 months of speculative
attack currency loss totaled $35 billion!!!After the first 3
months of 1999, US reserves went from $70 billion to about
$32.9 billion.
The Fall
Foreign InfluencesThe other currency crisis in Asia, Russia, and
Mexico made the peg increasingly fragileShort-term capital
flew faster into Brazil and the government had to sell off 10
billion dollars in reserves and hike interest rates from 21 to 44
percentThis worked for a short time until the crisis hit January
of 1999 unexpectedly
Decline of Reserves
Crisis Recovery
Managed a quick recovery compared to other major currency
crisis to date.Due to banking system being ready to handle both

5. severe economic shocks and policies.Commercial banks able to
take extreme measures to calm and stabilize markets.
A guy who came to International Finance for the first time, his
@$$ was a wad of cookie dough. After a few weeks, he was
carved out of wood.
-Johnny Stiver