|This article appears in the October 18, 2002 issue of Executive Intelligence Review.
IMF Check-Mates Itself in Brazil
by Dennis Small
You have to admit, there is more than a touch of irony in the situation surrounding Brazil's elections. In the weeks leading up to the vote, the international financiers holding Brazil's foreign debt— all $500 billion of it—extracted promises from every leading Presidential candidate, pro-government and opposition alike, that should they win the elections, they would maintain Brazil's current agreements with the International Monetary Fund (IMF). Backroom deals were cut, threats were delivered, and when the election rolled around, you could almost hear Wall Street breath a collective sigh of relief: "We're okay, boys. They've all agreed—including Lula—that they'll savage their economy before suspending debt payments. Thank goodness reason prevailed."
But reality has asserted itself and threw a couple of hitches into the Wall Street scenario. First, Dr. Enéas Carneiro kicked over the chessboard. In his congressional race, Dr. Enéas, the Brazilian politician most closely associated with Lyndon LaRouche's call for breaking with the entire IMF system—Dr. Enéas calls it ruptura—won more votes than any congressional candidate in the entire history of Brazil. Now all political bets in Brazil are off.
Secondly, the IMF has managed to place itself in check-mate in Brazil. It has engineered a debt bubble of such dimensions and characteristics there, that the IMF is about to destroy itself by successfully imposing its own policies. LaRouche recently explained the matter: "Any conditions that Brazil would capitulate to from the IMF, would, in effect, destroy Brazil; but that would also destroy the IMF itself. Whereas any action on the Brazil case which would be acceptable to the future of Brazil, which would actually enable Brazil to deal with its problem, would effectively bankrupt the whole IMF system. This is reality: If Brazil concedes, Brazil collapses and that causes a chain-reaction collapse of the IMF system. If the IMF concedes to Brazil, to reasonable conditions, the IMF collapses immediately—which is probably the best solution."
Consider the following evidence of LaRouche's case.
`The End of an Asset Class'
In 2002, there has been a dramatic contraction of foreign financial flows into the entire so-called "emerging market," but especially into Ibero-America. At the Oct. 1 Latin America Investor Summit, a meeting held in Washington, of company executives, bankers, investors and government officials, high-level World Bank officials revealed that private financial flows to emerging markets will total only $125 billion in 2002—as compared to $187 billion in 2001. This is a 33% decline, as compared to more moderate ups and downs over the previous four years (see Figure 1). These flows include both Foreign Direct Investment (FDI), as well as portfolio investment (purchases of bonds and stocks).
The regional picture for Ibero-America is even more dramatic. "Financial flows have really dried up in the region," Guillermo Perry, the World Bank's chief Latin American economist, told the gathering. As Figure 1 shows, foreign private capital flows into Ibero-America are expected to drop to a mere $25 billion this year, a shocking 64% decline from 2001's level of $70 billion.
These numbers are a reflection of this year's Argentine and Brazilian debt crises, in particular. Foreign banks and other creditors have simply red-lined the entire continent: they are refusing to lend new money; refusing to roll over or refinance existing loans; and mercilessly insisting that countries pay off their usurious debts on schedule, regardless of how many times that debt has already been repaid, and regardless of the social and economic consequences.
Even as they are pulling their own capital out of Ibero-America, these private speculators are demanding the IMF and the G-7 governments put public moneys in—provide massive bailout packages in the tens of billions of dollars. That way, they scheme, countries like Brazil will be able to pay back their private creditors, before they are driven to default.
Thus, the IMF approved a $30 billion bailout package for Brazil last August, which was the largest IMF loan ever granted to any country. But as LaRouche warned at the time, even that amount was grossly inadequate to cover Brazil's out-of-control debt bubble. An Oct. 2 wire from Bloomberg news service quoted Roger Scher, the top Latin American analyst at Fitch, Inc., the British credit rating agency, commenting: "If Brazil can't return to the market soon, then the IMF money is not enough," adding laconically, that Brazil will need $63 billion from the IMF in 2003. Inter-American Dialogue president Peter Hakim agreed: "Brazil is one of those countries that could knock everyone's cart off balance. The IMF can't just sit back and say, `We've done the best we can do.' " And mega-speculator George Soros howled that more IMF and G-7 money had to be thrown at Brazil now, to stop default.
At the Latin America Investor Summit, top management from Merrill Lynch, Wall Street's premier brokerage, presented their conclusion. Investors are "getting into a bunker. . .and staying there," said Jacob Frenkel, chairman of Merrill's international unit. If Brazil defaults, or there is other severe market instability in that largest of Third World debtors, this will "devastate confidence" in the sovereign (government) debt of the entire emerging market. Tulio Vera, a top Merrill Lynch researcher, added: "If we see a negative development in Brazil, that will call into question the viability of the asset class."
Just to be clear: the "asset class" being referred to so cavalierly, is the entire debt structure of the Third World and former East Bloc countries. It is these nations—and their populations—which Wall Street is now preparing to write off.
Some might ask: But is Brazil really going to default on its $500 billion in real foreign debt, or on its $335 billion in public debt (foreign and domestic)? Yes; default is no longer avoidable, regardless of who wins the Presidential run-off elections, and of what policies he announces. The IMF has made sure of that.
The problem can be summarized in a word: dollarization.
Dollarize, Devalue, Default . . . and Die
Consider the actual structure of Brazil's debt bubble. For the moment, focus on the public domestic debt—the bonds that the Fernando Henrique Cardoso government has issued over the eight years it has been in office (Figure 2). That debt rose from some 150 billion reals in 1994, to over 700 billion reals in 2002, an almost five-fold increase.
That is only the beginning of the problem. Brazil, under pressure from the IMF and "the markets," began to issue domestic bonds denominated in dollars, not reals. This foolishness really took off over the last two years, in order to "attract" foreign investors who were worried that a devaluation would catch them holding real-denominated bonds. So the proportion of Brazil's bonds that are dollarized has grown to over 45% today. That means that every time the real is devalued vis-à-vis the dollar, the government debt automatically rises—without borrowing a single additional penny.
Not surprisingly, the Brazilian currency has come under speculative assault by its own creditors, and has plummeted from 1.12 reals to the dollar back in early 1998, to about 3.88 to the dollar, as of this writing (Figure 3). That is a 71% devaluation.
That devaluation has driven up Brazil's total government obligations, as measured in reals; i.e., in terms of what must be extracted from the country's real economy to keep the bubble afloat (Figure 4). Today, that amount stands at a staggering 1.8 trillion reals.
In sum, 45% of Brazil's 700 billion real government debt is dollarized. Another 40% is interest-linked. Every 1-centavo decline in the currency boosts the debt by 3.5 billion reals; and every percentage-point rise in interest rates increases it by 4.2 billion reals. Meanwhile, the IMF and the speculators go merrily about simultaneously driving the real exchange rate down, and interest rates up. Result: Brazil's debt is arithmetically unpayable. Brazil stands at the edge of default—like it or not. The prestigious Financial Times of London recently explained to its often obtuse readers that, if the bail-out packages of Brazil prove insufficient, "this will not only destroy the fragile economy of Brazil, but also the very raison d'étre of the IMF."
Brazil reached this pass by following IMF orders to the letter: it dollarized; it devalued; it is about to default; and, if it stays on this policy trajectory, it will soon die, as neighboring Argentina is now dying.
LaRouche has emphasized the insanity of the dollarization of the debt: "On the Southern Cone debt situation, with this dollarization of the Brazil debt: the first demand has to be that the IMF agrees to cancel the dollarization, the increments of the debt based on dollarization. Reverse the dollarization as a great error, which creates an impossible situation, which threatens the continued existence of the IMF itself."
Brazil is not alone, as can be readily seen in the corresponding graphs for Argentina and Mexico (see Figures 5-10). The percentage of dollarization varies among the three cases, as do the time frame of the devaluations and the amounts by which the public debt has soared (as measured in local currency). But the pattern and the causality is identical: they each bear the unmistakeable finger-prints of IMF policy lunacy.
One of the bitter ironies of this situation is that, even if the IMF and Wall Street do, at some point, agree to restructure Argentina's defaulted debt, it will also now be necessary to "restructure the restructuring." In other words—an Oct. 1 article in Argentina's leading daily, Clarín, explained—the compensatory bonds, penalties, and capitalization of unpaid interest has been growing so rapidly over the last 10 months, that "even with a 70% write-off of the foreign component of the still not negotiated debt, the burden is unsustainable"—Argentina is simply unable to pay.
Clarín elaborated: "What kind of write-off is being discussed? The biggest one ever seen on the foreign markets. . . . In Russia and Ecuador, the reduction was only about 40%. . . . Barclays Capital is carrying out exercises that assume a write-off of 90% of the bonded debt, and even that way, closure would require a primary budget surplus on the order of 3% of annual GNP."
Argentina has even been driven to consider something never done before: the write-down of up to 30% of the debt it owes to multilateral agencies—the IMF, World Bank, and Inter-American Development Bank (IDB). The problem here is typified by the fact that the IDB has about 20% of its own loan portfolio in Argentina. Could it survive such a write-off? And what happens when Brazil, Mexico, and a dozen other countries join Argentina in writing down their debts to the IMF et al.? Who will survive, then?