The same kind of macroeconomic irresponsibility that was typical of Latin America (including Brazil) in the second half of the last century is becoming a major characteristic of the following 20 countries: Iceland, Greece, Portugal, Spain, Latvia, Ireland, Ukraine, Romania, Lithuania, Turkey, Bulgaria, United States (yes, USA), Australia, Japan (yes, Japan), United Kingdom (yes, UK), South Africa, France (yes, France), Russia, New Zealand, and Italy.
They have either current account balance-of-payments deficits greater than 4% of GDP (Greece has 12%) or Government deficits greater than 4% of GDP (Spain has 12%) – or both (the so-called “twin deficits”).
This explains basically why many of these countries are facing major increases in terms of country risk. In particular, Greece and Spain are major concerns now, as far as sovereign risk is concerned – and, additionally, Iceland, Portugal, Latvia, Lithuania.
Many years ago, one Finance Minister of Australia said he was worried about Australia becoming a “banana republic”, with 4% “twin deficits”. It seems that Australia hás been able to learn to live for many years with huge twin déficits, because – just like Brazil – it is a commodity-based country. But Iceland, Greece, Spain and Portugal are facing serious troubles.
One major aspect of course is that some of these new “banana republics” have “eternally” fixed exchange rates against strong countries such as Germany, because of the euro. It is clear that the euro as a single currency is now a major problem, given the major differences in the European countries in their fiscal positions and balance-of-payments positions. Some economists are discussing new exchange rate arrangements within Europe and this might very well happen in the next few days.
When we look at the numbers in Brazil, the situation is more comfortable: 2% current account deficit and 3% Government deficit (thanks to good macroeconomic policies in the last 15 years). But these are 2009 figures. For 2010, both numbers might deteriorate significantly. The Government is spending too much with taxation reaching a certain “limit”. The trade balance is being severely affected by the overvaluation of the exchange rate.
There is a theory now that countries with big domestic savings (like China) may have undervalued exchange rates, but countries such as Brazil and Australia, with low domestic savings (notice that the current account of the balance-of-payments is exactly the measurement of “external savings”) cannot afford competitive exchange rates: their currencies would tend to be “normally” overvalued.
We believe that the causality is the other way around: Brazil and Australia, as well as other commodity-based countries, are slowly generating export/import problems and consequently external deficits, because their exchange rates are very far from equilibrium, excessively overvalued.
However, in contrast to some of the new European Banana Republics, at least their exchange rate system allows some external adjustment through fluctuation of their currencies.
We believe that 2010 will be again – just like during the Bretton Woods years – one new year when exchange rate “problems” (and eventually “crises”) will come back to the economic forefront. After all, we have the problem of the euro as one single currency for very different countries, the question of the undervalued Chinese currency, and finally the fact that some commodity-based countries such as Brazil, Canada, Australia, and Chile with overvalued exchange rates will probably face a reversal of currency bubbles, even under a potential new situation of higher nominal interest rates in these countries .
By the way, just to be complete, when we look at the figures for CDS spreads, the above analysis indicates precisely the most risky countries ( basically, Europe with a few exceptions particularly Germany). But there are some exceptions for this overall picture, including some of the old Banana Republics in Latin America such as Venezuela and Argentina. Interestingly enough, Argentina has good numbers for the twin deficits but they have been facing a major confidence crises for the past few years.
It is clear now how difficult it is to have one single currency in a continent like Europe. After all, in contrast to one single large country (such as Brazil or the United States), movements of labor and capital within Europe from one country to another are not entirely free. Furthermore, fiscal policies for each country are quite different. Unless a major “aid program” is not announced by the strongest countries, something is bound to happen with the euro in the next few weeks – probably a dual currency system.
Just a final comment on Brazil: although we are much better as far as deficits and debts are concerned, this is being achieved with a major cost: a great tax burden. Brazil today is ranked among the countries with the highest tax rates in the world: around 40% of GDP. For the long run, this is not compatible with a dynamic country which intends to grow at more than 5% per year.
Antonio Carlos Lemgruber
Former President of the Central Bank of Brazil, presently with Atico Asset Management (Rio de Janeiro, Brazil)