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How to create a financial crisis by trying to avoid one: the Brazilian 1999-financial collapse as "Macho-Monetarism" can't handle "Bubble Thy Neighbour" levels of inflows

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  • Palma, J.G.
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    Abstract

    Brazil, as the rest of Latin America, has experienced three cycles of capital inflows since the collapse of the Bretton Woods system. The first two ended in financial crises, and at the time of writing the third one is still unfolding, although already showing considerable signs of distress. The first started with the aftermath of the oil-price increase that followed the 1973 ‘Yom Kippur’ war; consisted mostly of bank lending; and finished with Mexico’s 1982 default (and the 1980s ‘debt-crisis’). The second took place between the 1989 ‘Brady bonds’ agreement (which also marked the beginning of neo-liberal reforms in most of Latin America) and the Argentinian 2001 crisis. This second cycle saw a sharp increase in portfolio flows and a rise of FDI, and ended up with four major crises (as well as the 1997 one in East Asia) as newly-liberalised middle-income countries struggled to deal with the problems created by the absorption of those sudden surges of inflows — Mexico (1994), Brazil (1999), and two in Argentina (1995 and 2001). Finally, the third inflow-cycle began in 2003 as soon as international financial markets felt reassured by the surprisingly neoliberal orientation of President Lula’s government; this cycle intensified in 2004 with a (mostly speculative) commodity price-boom, and actually strengthened after a brief interlude following the 2008 global financial crash. The main aim of this paper is to analyse the Brazilian 1999-financial crises during the second inflow-cycle from the perspective of Keynesian/ Minskyian/ Kindlebergian financial economics. I will attempt to show that no matter how diversely the above mentioned countries tried to deal with the inflow absorption problem — and they did follow different routes, none more unique than Brazil — they invariably ended up in a major financial crisis. As a result (and despite the insistence of mainstream analysis and different ‘generation’ models of financial crises), these crises took place mostly due to factors that were ‘intrinsic’ (‘endogenous’ or ‘inherent’) to middle-income countries that opened up their capital account indiscriminately to over-liquid and excessively ‘friendly-regulated’ international financial markets. As such, these crises were both fully deserved and fairly predictable. Therefore, I shall argue that the general mechanisms that led to Brazil’s 1999-financial crisis were in essence endogenous to the workings of an economy facing i) full financial liberalisation; ii) several surges of inflows, especially immediately after the Mexican 1994 and the East Asian 1997 crises — and as a spillover of the respective rescue packages —, following a new ‘bubble thy neighbour’ speculative-strategy by international financial markets, as ever more liquid, volatile, politically-reassured, and progressively unregulated financial markets were anxiously seeking (and allowed to create artificially) new high-yield investment opportunities via a new sequential speculative-strategy; and iii) ineffective domestic financial regulation — especially lack of effective capital controls. I shall also argue that within this general framework, the specificity of the Brazilian crisis was given by having been affected by i) several external shocks; ii) by a naïve ideology directing economic reform; iii) by a exuberant (post-‘second generation’ models)-style monetarism, or ‘macho-monetarism’, that although successful in achieving initially price-stabilisation, and in avoiding that Brazil became ‘another Mexico’ (in terms of keeping Brazil away from an inflow-led Kindlebergianmania), it did so at a growing (and mostly unnecessary) cost; iv) the creation of several major financial fragilities in the banking sector (private and public) and in State finances — leading the Federal Government to sleepwalk into a Minskyian ‘Ponzi-finance’; and v) by this ‘Ponzi’ being turbo-charged by both the Government’s indiscriminate absorption of nonperforming debt, and by it paying a huge amount (mostly in the form of subsidies) in order to get the constitutional re form that would allow the President to run for a second term.

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    File URL: http://www.econ.cam.ac.uk/research/repec/cam/pdf/cwpe1301.pdf
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    Bibliographic Info

    Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 1301.

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    Date of creation: 29 Jan 2013
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    Handle: RePEc:cam:camdae:1301

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    Web page: http://www.econ.cam.ac.uk/index.htm

    Related research

    Keywords: ‘Endogenous’ financial crisis; ‘Second generation’ models; Neo-liberal economic reforms; Ideology; Financial liberalisation; Capital controls; Systemic market failures; Latin America; East Asia; Keynes; Minsky and Kindleberger;

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    References

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    1. Roberto Frenkel, 1998. "Capital Market Liberalization and Economic Performance in Latin America," SCEPA working paper series. SCEPA's main areas of research are macroeconomic policy, inequality and poverty, and globalization. 1998-06, Schwartz Center for Economic Policy Analysis (SCEPA), The New School.
    2. Jonathan David Ostry & Mahvash Saeed Qureshi & Karl Friedrich Habermeier & Dennis B. S. Reinhardt & Marcos Chamon & Atish R. Ghosh, 2010. "Capital Inflows: The Role of Controls," IMF Staff Position Notes 2010/04, International Monetary Fund.
    3. Gabriel Palma, 2000. "The Three Routes to Financial Crises: The Need for Capital Controls," SCEPA working paper series. SCEPA's main areas of research are macroeconomic policy, inequality and poverty, and globalization. 2000-17, Schwartz Center for Economic Policy Analysis (SCEPA), The New School.
    4. Palma, J.G., 2010. "Why has productivity growth stagnated in most Latin-American countries since the neo-liberal reforms? (Revised 26-07-2011)," Cambridge Working Papers in Economics 1030, Faculty of Economics, University of Cambridge.
    5. Robert E. Lucas, Jr., 2004. "Keynote Address to the 2003 HOPE Conference: My Keynesian Education," History of Political Economy, Duke University Press, vol. 36(5), pages 12-24, Supplemen.
    6. Palma, J.G., 2011. "Homogeneous middles vs. heterogeneous tails, and the end of the ‘Inverted-U’: the share of the rich is what it's all about," Cambridge Working Papers in Economics 1111, Faculty of Economics, University of Cambridge.
    7. José Gabriel Palma, 2005. "The seven main "stylized facts" of the Mexican economy since trade liberalization and NAFTA," Industrial and Corporate Change, Oxford University Press, vol. 14(6), pages 941-991, December.
    8. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    9. José Gabriel Palma, 2009. "The revenge of the market on the rentiers," Cambridge Journal of Economics, Oxford University Press, vol. 33(4), pages 829-869, July.
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