Brazil’s growth rate will approach 5% in 2007. What about 2008? Too dependent on the external demand for commodities, Brazil will suffer from a downturn in the U.S. It has become a cliché to compare Brazil’s mediocre GDP growth (around 2.5% a year over the last 25 years) to the resounding growth of China (10% a year over the same period). A similar contrast appears in relation to South Korea. In 1960, South Korea had a smaller GDP per capita in purchasing parity dollars than Brazil. Today, thanks to sustained growth over 45 years, its GDP per capita is four times larger than Brazil’s. Economists have argued that the difference can be found in exchange rate behavior. For decades, the exchange rate was maintained stable and undervalued both in South Korea and in China. In contrast, the rates of exchange for Brazilian currencies (the cruzeiro, the cruzeiro novo, the cruzado, and the real) suffered from strong oscillations and overvaluation. By mid-2007, the real exchange rate in Brazil once again looked overvalued relative to its historical values. Part of the appreciation between 2005 and 2007 could be attributed to the downward movement of the dollar in relation to most currencies. The counterpart to the flight of the dollar was the comparative increase in the value of other currencies. However, this has been particularly accentuated in the case of the real. Yet if the improvement in Brazil’s terms of trade were to be permanent, we should expect a more appreciated long term equilibrium exchange rate than the average historical rates. And it is possible that the success of ethanol will result in a longer lasting improvement in Brazil’s terms of trade, which would justify an exchange rate higher than that in the past. On the other hand, there are reasons to suspect the real is overvalued in relation to this new equilibrium. In the first place, in the move toward a new equilibrium, exchange rate overshooting is common. And the recent loss of export dynamism seems to point to overvaluation. Moreover, in 2005 and 2006, around 2,000 companies abandoned the export sector. Brazil’s exporting companies are bigger, more productive, employ more specialized labor and pay better salaries than those which do not export. They are more productive because, immersed in a very competitive market, they learn the methods and processes of their rivals. If the increase in the number of exporting companies contributes to gains in productivity and, therefore, promotes long term growth, the reduction of exporting companies has the opposite effect. Excessive overvaluation is harmful to sustained growth because it expels firms from the export sector and, thus, reduces productivity growth. Stable and competitive exchange rates in Asia were made possible by price stability in conjunction with fiscal equilibrium. Brazil, on the other hand, headed in the opposite direction, experiencing diverse regimes over the last decades. In the 1980s, it moved back and forth between indexation of the exchange rate and freezing of prices (including exchange rates) in an attempt to combat inflation. Since 1999, the exchange rate has fluctuated. Although the exchange rate regime changed, government spending continued to increase. Monetary policy has kept inflation in place, but price stability had to rely on high interest rates and exchange rate appreciation. This is the opposite of a sustained growth recipe.