I’m not sure what’s more infuriating: witnessing Brazil’s drawn out slow-motion crash and burn after an endless string of stupid policies over the past year; the sudden breakdown in devaluative stupidity; or enduring the lame economic analysis that ensued in the days after devaluation. Initial reports were so bizarre and non-sensical as to leave me wondering whether some cloaked parties had prepared in advance to put a misleading “spin” on the situation.

There was a great din made in the press about Brazil’s leaders “making the tough but right choice”. It was astounding to see how many pundits cheered Brazil’s currency devaluation, suggesting that it somehow “cleared the way for recovery” or would “boost Brazil’s competitiveness”.

The media loved that the Brazilian market, in local terms, surged as much as 20% in a day. Few emphasized, however, that the free-falling currency was sapping away the gain when measured in dollar terms. Does anyone remember the Thai market surging just after the baht devalued? Government officials there also initially heralded the devaluation as a major positive and the IMF stupidly reinforced the thinking. Economists droned on about the “J-curve effect”, meaning that after a quick economic dip, newfound competitiveness would bring strong economic growth. It sounded so good that many other Asian countries wanted a piece of the action.

Of course, the devaluations turned out to be an unmitigated disaster.

Make no mistake: the vast majority of Brazilians will be worse off as a result of the devaluation. Inflation will rise, interest rates will remain high until the “real” stabilizes, the economy will experience negative growth, and uncertainty will hamper Brazilian economic decision-making for years to come. The devaluation will also make it harder, not easier, for the government to reduce its profligate spending.

Some proponents of devaluation naively purport that Brazil, as a major exporter, will benefit extensively from the increased competitiveness of having costs in local currency. But Asia was also a net exporter, and the devaluations there actually caused exports to decline in dollar terms, due to trade turmoil and lower prices. For most Brazilian companies, operating and financing costs will rise due to devaluation-created inflation, stealing back any initial overall competitive gains. And few companies live by exports alone.

Others point out that Brazil is not as indebted as was Asia, and thus will not be hurt as much by the devaluation. But a devaluation has a way of uncovering “hidden” debts. For instance, nobody knew how indebted Korean conglomerates really were until the devaluation. Companies with substantial foreign debt (such as some recently privatized utilities who took the government at its word regarding currency stability), are in for some seriously tough times.

Finally, many are counting on the devaluation to “force the Brazilian government to make major reforms”. In fact, it’s much more difficult, politically, to cut government spending when an economy is in an inflationary recession. Plus the devaluation, in one quick stroke, made existing government debt much more expensive to repay.

U.S. officials and the IMF could have provided a better solution for Brazil. They could have made aid contingent upon setting up a currency board (utilized with great success by countries like Argentina and Hong Kong), or (“gasp!”) moving to the gold standard. But of course, “orthodox” economists hate these systems, despite their enviable track records. [Good reading: “Gold and Liberty” by Richard Salsman.]

The purpose of a currency is to serve as a facilitator of exchange, and a store of value over time. A currency whose value swings wildly does not facilitate a people’s ability to make long term economic plans, produce goods, calculate profits and losses, or save for the future

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Andrew West

Andrew West is a Contributing Economics Editor for Capitalism Magazine. In 1997 he received the Chartered Financial Analyst designation from the Association for Investment Management and Research.

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