Brazil Is the New America: How Brazil Offers Upward Mobility in a Collapsing World (30 page)

They did the same thing when it came to reserve requirements. Reserve requirements for Brazilian banks have been dramatically higher than those in the United States, Britain, and other advanced economies. The purpose of bank reserves is to absorb losses and provide liquidity to stabilize the financial system in times of crisis. The drawback of high reserves, from the perspective of politicians and aggressive bankers, is that they deleverage the system.

In Brazil before the crisis in 2008, banks were required to sequester 30 percent of their deposits with the central bank. In the United States, the notional level of reserves was 3 percent. But in reality regulatory interpretations allowed U.S. banks to operate free of any reserve requirements.

Due to “deposit reclassification” and other slippery interpretations instituted by the authorities to increase leverage in the banking system, U.S. banks were permitted to count their vault cash toward their reserve requirements, rather than actually depositing reserves with the central bank. This may not be quite as silly as counting the cost of the bank safes, desks, and furniture in the lobby toward reserves. But it's close. Even without any notional reserve requirements, banks would have to hold vault cash in any event—for use in their day-to-day operations in ATM machines and to satisfy customer withdrawals.

U.S. reserve requirements have been effectively nil for many years. Ironically, the Fed took a dramatic step on October 6, 2008, to make holding reserves more attractive to banks. On that date, the Fed began paying interest on banks “required and excess reserve balances.” This is better understood as part of the multifaceted, multitrillion-dollar bailout of the banking system than as a step toward more measured regulation. As of November 2011, U.S. bank reserves had swollen to $1,591,900 million, as essentially insolvent banks opted to make deposits with the Federal Reserve rather than lend to customers.
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You can gain a better perspective on the precrisis effectiveness of U.S. reserve requirements from the fact that at the end of 2008, total reserve balances on deposit with the Federal Reserve amounted to less than $9.5 billion—a trivial sum compared to a banking system whose total liabilities totaled $13.5 trillion.

When Lehman Brothers went bankrupt and the global credit crisis hit its most severe moment to date, U.S. banks had virtually no reserves upon which to fall back. The amounts they could have swept out of their ATM networks could not have come close to backstopping their liquidity needs.

By waving bank reserve requirements, the U.S. authorities determined that taxpayers would provide the reserves for U.S. banks. It has long appeared to political authorities that abetting the growth of leverage improved the ability of consumers to generate wealth and obtain the good things that wealth affords, such as a new car, the latest fashions, or, more importantly, a home.

Even if this implied long-term ruin to a degree they failed to grasp, it was politically irresistible for politicians of both the right and the left to employ credit and leverage to facilitate even a temporary appearance of prosperity. The same political impulse that impelled politicians in the United States and Britain to scrap the gold standard also impelled them to favor easy money and ever greater leverage in the economic system.

As a result of this consensus, banking systems in both countries have been skirting the consequences of insolvency since 2008. In my view, there is a high likelihood that living standards that were inflated by decades of easy money will be deflated in the years to come as the North Atlantic economies are deleveraged. (Note that multi-trillion-dollar Treasury- and Fed-sponsored bailout programs supported up to 73 percent of the balance sheet of U.S. banks; the costs of these bailouts have only begun to be tallied.)

In Brazil, by contrast, the authorities were much less cocksure that they could control systemic risk. They were more concerned about avoiding the potentially ruinous consequences of a banking crisis. Consequently, they adopted more measured and conservative banking regulation. Having experienced recurring crises as they sought to distance themselves from the hyperinflation of the 1980s and early 1990s, they were more sensitive to the downside of leverage.

Rather than vitiating reserve requirements, Brazilian authorities successfully restrained the growth of debt by mandating high bank reserves.

When the global economic crisis triggered by the subprime collapse suddenly hit Brazil in September 2008, the authorities were in a position to respond. Of course, the crisis in Brazil was minimized because the Brazilian banking system was solvent. Brazil had no subprime problem. It scarcely had any mortgage debt at all. And far from indulging the fantasy that lending to government is riskless, Brazil had seen its state banks lose tens of billions that way, and prohibited such loans altogether.

The conservative regulation of Brazilian banks assured that unlike American and British banks, Brazilian banks were not highly leveraged.

During the liquidity strains caused by the flight of billions of dollars in hot money, the Central Bank of Brazil simply allowed the banks to access their reserves deposits to absorb losses and increase liquidity. In other words, Brazilian taxpayers were not called upon to backstop the banks because they had adequate reserves.

Speaking soon after the crisis, Banco Itau's Bracher made his pronouncement quoted at the head of this chapter:

None of the Brazilian banks has come under the suspicion of being weak. The balance sheets are very strong. The Brazilian corporate sector is extremely underleveraged. The Brazilian citizen is underleveraged. The credit to [gross domestic product] ratio in Brazil is just above 30 percent. It used to be in the low 20 percent range. And 30 percent is still quite a low figure.
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By contrast, total government corporate and individual debt in the United States was guesstimated by the Federal Reserve at 371 percent of GDP in 2009 about the time of Bracher's comments.

Another statistical mirror of Brazil's different position in the leverage cycle is the fact that only about one-third of the home sales in Brazil in the middle of the past decade were assisted with mortgage finance of any kind. Leverage was as low as it can be when you have to make a 100 percent down payment to buy a house. And the mortgage credit that has heretofore been available in Brazil was more akin to that available in the United States in the 1920s than the terms that became familiar during the subprime boom, with the Alt A, or “Liars' Loans,” when borrowers frequently took cash back from mortgaging residential real estate for more than 100 percent of its value, without even documenting their income. By contrast, Brazilian mortgages are typically extended for only 10 years on a fraction of appraised value at punishingly high interest rates.

Through an ironic twist of history, Brazilians have become the new Scots. They abhor debt the way my Scots ancestors once did. No, the Brazilians did not suddenly become Presbyterians. The Brazilian distaste for debt was formed in the crucible of economic trauma. With an average of 60.5 percent interest rates on consumer loans as recently as June 30, 2002, it's little wonder that consumers in Brazil have tended to shun credit.

This all happened recently—within living memory even for young Brazilians—in the wake of a trillionfold increase in the price level after 1980. That hyperinflation coincided with complete stagnation in real income growth in Brazil. This underscores one of the many paradoxes in economics. Although hyperinflation rewards debtors by wiping out the value of money, it also wipes out credit, so no one can borrow money.

In the aftermath of hyperinflation, credit usually becomes scarce, and the costs of borrowing rise. Largely as a consequence of hyperinflation, Brazil has had the world's highest real interest rates for the past decade. High real interest rates encourage savings and punish borrowing. High real interest rates have kept Brazil relatively free of excess private sector debt.

The fact that the U.S. government was considered unquestionably creditworthy encouraged U.S. officials to take a cavalier attitude about protecting the nation's balance sheet. Brazilian officials, on the other hand, conscious that Brazil's ability to borrow internationally had been repeatedly called into question during crises as recent as 2002, took much more care to strengthen their fiscal and monetary posture.

Four major planks in Brazil's financial framework dramatically underscore the more measured and conservative approach Brazil has taken:

Contrast this with the United States where unfunded liabilities have been ballooning to a fantastic degree. The president of the Federal Reserve Bank of Dallas, Richard Fisher, has lately seemed something of an optimist as his once-lofty estimate—$104 trillion—of U.S. unfunded liabilities made late in the last decade barely exceed 50 percent of Kotlikoff's more recent reckoning at $202 trillion. Take your pick. They are equivalent to a choice between drowning in 104 feet or 202 feet of water.

Left
unreported
was the fact that the discounted present value of entitlement debt, over the infinite horizon, reached $104 trillion. This is almost eight times the annual gross domestic product of the United States—and almost 20 times the size of the debt our government is expected to accumulate between 2009 and 2014.

And while the announcement that the Social Security trust fund will begin its decline one year earlier is an important fiscal event, the swelling of overall entitlement debt to more than one hundred trillion dollars has far more serious implications for economic growth—implications we are poorly positioned to address given the budget deficits we face today.

One spoilsport budget analyst reacted to Fisher's comments by calculating that meeting the unfunded liabilities of the U.S. government will require a 68 percent increase in U.S. federal taxes.

Clearly, U.S. politicians were thinking ahead when they established the peculiarly predatory system of taxation that made income taxable by citizenship rather than residence. If the U.S. taxed as almost every other country does, by domicile, the airports and ports would be crowded with people heading for the exits.

Even so, I still think there may be a strong argument for getting out. Unless you are convinced that the fiscal and monetary framework, the tax regime, and the prospect of monetary disruption are almost completely irrelevant to your prospect of success, you have to recognize that the United States faces dire straits in the years to come. “Weimer Republic, the Sequel” is almost a best case scenario. (One aspect of the unfunded entitlement liabilities to which Fisher refers is that they are not susceptible to being erased by hyperinflation; Social Security and other government pension funds are indexed to inflation.)

In April 2010, my colleague Charles Del Valle suggested in a comment that Brazil is the New America. His conclusion is informed by Brazil's deleveraged position in the credit cycle. The difference in leverage between the United States and Brazil has been truly startling. The United States and Brazil are on opposite extremes of the leverage cycle. Mortgage debt in the United States stood at 75.7 percent of GDP. In Brazil, all mortgage debt amounted to less than 2 percent of GDP. Other debt aggregates are similarly lopsided. In 2008, the average credit card debt of an American consumer was 41 times higher than that of his Brazilian counterpart.

As we explore in this book, Brazil's emerging middle class shows signs of taking up the bad habits of U.S. consumers, embracing fast food and credit card debt. By 2012, Brazil's consumers were both fatter and more leveraged than they were when the Great Contraction struck.

Meanwhile, both obesity and insolvency are rarer among Brazilian consumers than those in the United States. In addition to conventional statistical measures of the different position of Brazil and the United States in the leverage cycle, there is further evidence that will more vividly strike the eye of a visitor to Brazil: the relationship between fashion and the credit cycle.

As a man, I would much rather see a young woman in a skimpy Brazilian bikini than draped in a generous
burqa
. Roughly speaking, two Brazilian bikinis could be fashioned from the fabric in a single handkerchief. This makes Brazil's the most efficient fashion for covering a female form since manufactured clothing replaced pelts and feathers.