Normal Gall, "Games Bankers Play," Forbes, December 5, 1983

Main Point: Brazil’s inflation and growth went hand in hand for a short time period. Eventually excess government spending, mass printing of money and unproductive government companies caused prices to rise faster than growth. Brazil borrowed so much that it could not pay back its outstanding loans.

Summary: During the early years of the 1980’s Brazil managed to acquire over 100 billion in loans. Although a significant percentage of this borrowed money was spent on productive investments such as infrastructure, factories and a telecommunications network, a larger portion of the money was distributed for unproductive activities. Much of it was used to allow handouts to the working class, the middle class and the wealthy to help rectify decades of unpopular military rule. Over the life span of those loans, continuous inflation, rollover of debts, and inconsistency in financial management prohibited Brazil from servicing many of its debts.

After numerous unpaid loans, U.S. banks and financial institutions around the world realized that Brazil was not in a position to pay back many of the loans. Infact, while many lenders sought for Brazil to pay them back, Brazil was digging its self in a larger hole.

Norman Gall asked the question, who is to blame for the numerous outstanding loans. Should the lenders be blamed? They knew that Brazil had an inconsistent market with sky rocketing inflation, and would eventually not pay back the debt. Or should Brazil be guilty of searching for new million dollar loans to finance its incomprehensible government expenditures?

How the mess was started:

Up until 1982 Brazil went through a fast paced growth period. The standard of living in various sectors of the economy improved and the percentage of middle class also increased. This tremendous growth was enticed by domestic inflation and monumental borrowing abroad.

The inflation was caused because the Brazilian government printed massive quantities of money to monetize its debts and increase government spending without having to tax the people. Therefore the situation was blamed on inflation rather that pointing the finger towards government spending.

With the increase of money supply, the quality of life improved for a short time period. Eventually inflation was so out of control that Brazil could no longer compete with raising costs of living and leaving it unable to repay its debts.

The inadequacy of imposition of efficiency measures of many state corporations caused their productivity to be uncharacteristic of profitable companies. Thus, leaving them with billions of dollars of debt to banks, contractors, and suppliers. Many government corporations permitted politically motivated payroll padding, poor supervision and politically motivated contracting. The limitless borrowing of money for a while made them immune to cash-flow problems, overstaffing, insecure investments and fringe benefits.

The Gamble by Netto:

In 1979 Brazil’s minister of planning, Antonio Delfim Netto, launched a new economic policy. He promoted the overcoming of inflation by fighting it with growth. He expanded rural credit by distributing cheap money to increase agriculture harvest. But many used the money in high money markets. Second he approved an income policy that pegged wage increases above inflation. The result of this plan caused inflation to increase instead of alleviating it. Soon enough employers were unable to maintain high wages and were forced to lay off. In a reaction to the situation, Brazil’s government borrowed more money to make up for the lack of tax money that was used for government spending. By this time the credit line was so volatile that companies helped by also borrowing from banks abroad. Borrowing by companies did stop when Delfim steeply devaluated the cruzeiro. The devaluation also made companies unable to service its present loans.

Result: Brazil was hooked on credit but could no longer keep it.

Events Gall recognizes as part of the debt crises:

After the devaluation the IMF tried to govern internal measures to curb government deficit

Companies declare Chapter 11 to avoid bankruptcy

In September 82 new central bank president Affonso Celso Pastore went to several cities in hopes of acquiring a new 11 billion rescue package including a 6.5 billion jumbo bank loan for 1983-1984

The jumbo plan wouldn’t get banks out but would increase debt past 100 billion mark

Brazil attempt to correct its deficit by cooperating with the IMF has caused severe stresses on its society

334% food price increase

beans and potatoes multiplied fourfold

Small Banks to the Rescue

In the middle of all the trouble that the big banks have incurred the smaller banks have helped out by providing a lot of the money Brazil needed. Their reluctance to agree to join in the 6.5 billion Brazilian jumbo plan (essentially political reasons) was also accompanied by a warning that it would be the last time they participated in such actions. German and Japanese banks also joined the rescue for political reasons but wrote of much more of their bad foreign loans.

Eventual default was not a probability but an inevitability. However default could be managed and there were plenty of long-term solutions. Such solutions include conversion of loans into long term low interest debts administered by the World Bank, the IMF, or some new international agency. This form of bailout would present less political controversy. Also the sell of Brazilian debts (60 cents on the dollar) were making there way throughout European markets.

Another such proposal came from Professor Rudiger Dornbusch who suggested implementing Brazilian government bonds that would sell at less than 100 cents on the dollar but would increase liquidity.

Conclusion:

Gall concludes by stating that the real issue is not to attempt to collect all debts but must be dealt with in a way that promotes credit flow to finance trade and to finance productive enterprise.

Summary by Samuel Serrano