Saturday, September 25, 2010

Brazil Moves to Protect Currency

Sources: Fundo Soberano já pode comprar dólar Brazil Pressured for More Action on Strong Real Brazil’s Central Bank Buys 5.9 Billion USD to Contain Revaluation of the Real Brazil’s Real Weakens on Cenbank Threat Government Threat Fails to Dent Enthusiasm for Brazil’s Real

Brazil’s government made a concrete decision to protect the value of its currency (the real) from further appreciation. The real has appreciated 100% since 2003, the year current President Luiz Inácio Lula da Silva took power, and 5% since the end of June 2010. This appreciation makes it cheaper for Brazilian companies and consumers to buy foreign imports, but more expensive for foreigners to purchase Brazilian exports, thus pushing those customers towards other cheaper markets and hurting Brazil’s bottom line. The government has warned that the real’s continued appreciation against the U.S. dollar threatens to derail its current economic growth.

The situation has been further affected by the announcement that the state-owned oil company, Petrobrás, will be making the world’s largest stock offering ever at $78 billion (R$134 billion) after discovering massive oil reserves offshore. Because priority will be given to purchasers in Brazil, foreign investors have flocked to the country, converting their U.S. dollars to Brazilian reais, thus increasing the supply of dollars in the country and increasing the value of the real. This trend should end after the sale, and the flow of dollars in and out of Brazil should return to a lower level.

The Brazilian government has authorized its own sovereign wealth fund to purchase dollars to ease the upward pressure on the currency. By law, those U.S. dollars cannot stay in Brazil so they will be invested in stocks overseas or deposited in foreign banks. The government has also increased the amount of dollars it purchases in daily currency auctions and increased the number of daily auctions to two from one normally to try to lower the value of the real.

The government is walking a fine line with its currency. If the government’s policies are too effective and the currency depreciates too much the country could face inflation, which would likely put the brakes on domestic spending and thus slow any growth driven by domestic consumption. A turn-around in the stagnating U.S. economy could ultimately be the best medicine for Brazil’s currency issues as the dollar would increase in value to maintain the current exchange rate even as the real increases in value.

1) How can currency adjustments be justified in an economic world controlled by the “invisible hand” of the free market?
2) The U.S. is currently upset with China because of its policy of keeping the yuan artificially low. How do you think that dispute might affect economic issues between the U.S. and Brazil, a country that—like China—has many industries that compete with U.S. industries (ethanol, cotton, and sugar are three good examples)?

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