Friday, January 21, 2011

A Tale of Two Hemispheres

Dilma Rousseff.  |  Photo credit: BBC
The USA, the world's economic engine struggles to find a way out of the deep, deep recession.  Meanwhile down in the hemisphere, Brazil has an entirely different problem: how to escape the slings and arrows of outrageous fortune. When I was there in December is was like the world had turned topsy-turvy, the US was in the doldrums and Brazil was positively humming - strong growth, full employment and (predictably) struggling to contain inflation.

My Dilma had just been elected and my economist friends were withholding judgment beacuse they just didn't know what to expect. They were troubled by signs that she may threaten central bank independence and block a move to increase interest rates in an effort to put the breaks in inflation fearing that higher interest rates would be unpopular with the working class - her main constituents.  I imagine they are all feeling a little reassured as the central bank has just announced an interest rate hike.

The BBC has the skinny:

Brazil's central bank has raised its key interest rate to 11.25% in a bid to cool inflation in one of the world's fastest growing economies.

The rise, from 10.75%, is the first under President Dilma Rousseff and central bank head Alexandre Tombini, both of whom took office this month.

Inflation was 5.91% last year and is forecast to remain above 5% in 2011.

But the rate rise risks sucking in foreign money, adding to pressure on the already overvalued Brazilian real.

The central bank warned that the rate hike may be just the start of a series of rises to curb inflation.

Capital inflows from outside Brazil have soared as investors flee record-low rates in more developed countries.

The strengthening of the real has hit Brazil's manufacturers hard because their exports have become more expensive.

But Brazil needs to do more to rein in a massive consumer credit boom which has helped fuel the economy's rapid growth.

The economy, Latin America's largest, grew more than 7% in 2010 and is expected to grow between 4.5% and 5% this year.

Other anti-inflation measures have included a big increase in banks' reserve requirements to hold back lending.

Think about how estraordinary this is given where we are as a country. Our central bank has had interest rates at essentially zero for well over a year now and we worry about deflation, while Brazil is booming so much that they are worried about too much inflation.  11.25% prime interest rate?!?  Wow.  And this is not at all the old Latin American story of too loose a monetary policy to appease the masses which lets inflation get out of hand, this is pure old fashioned economic growth.

The exchange rate problem is a serious worry however, and one with no easy answer.  When I was in Brazil in 2008, the a Dollar bought 3.5 Reals, last December I got 1.5 Reals form my Dollar and boy did it hurt.  Everything was expensive in Sao Paulo (already a very expensive city) and I had to think hard before I spend my money.  This is the same for the stuff Brazil exports - foreign buyers will find it more and more expensive and will cut back or cease to buy at all.  Brazil is worried and for good reason - they don't have the Chinese ability to keep the exchange rate artificially low.  So a natural brake on Brazil's growth is going to happen, but Brazil will still be doing a lot better than the US.  Parabens!

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