Helio Beltrão: Disastrous Fed reinvigorates a good Friedman idea

Since Fed Chairman Jerome Powell’s speech on Friday (26) in Jackson Hole, markets have been falling. Powell, long overdue, woke up and swore to fight inflation without ceasing, until he got back on target. This is the Fed with the worst credibility since the disastrous administration of Arthur Burns in the 1970s. Because it took too long, it will have to raise interest rates more intensely and for a longer period.

What do Brazil and emerging countries have with this? Potentially a lot. Whenever dollar interest rates rise sharply, something breaks in the world, particularly in the most fragile emerging countries.

In 1994, working in the financial market, I witnessed the consequences of rising interest rates for fighting inflation. The Fed raised interest rates from 3% to 6% and triggered a severe crisis in Mexico, the “Tequila” crisis, which devalued the Mexican peso by more than 40%. Short-term interest rates multiplied sevenfold in Mexico and tripled in Argentina. In Brazil, which launched the Real Plan, the Selic rate was above 50% per year and hit 85%, astonishingly, at the height of Tequila in early 1995.

The crisis generation mechanism is almost always the same. With the rise in interest rates, the dollar tends to get stronger, commodities tend to fall, and funding for emerging markets decreases. The currency depreciates and debt service (external and internal) rises, compromising growth. At some point, external funding collapses and the window of external funding closes. The economic cycle collapses and there is no alternative to rising interest rates. It’s time to pay for previous periods when central banks spouted credit to boost the economy, pricing interest rates artificially low.
The optimism of the American Stock Exchange of the last few weeks proved to be precipitous.

The market came to believe that the Fed would not dare raise rates above 3% or 3.5% at the end of the adjustment process in 2023 or 2024. But another 0.75 point hike is now expected (the third in a row). next month, surpassing 3%.

The recession has yet to set in, but most believe in a “hard landing” with economic activity slumping sometime in the next 12 to 18 months. Powell himself admits that a substantial period of below-average growth will be needed. The toxic era of the Fed bailing everyone out with a cash injection is coming to an end — as I warned in June and November of last year and in January of this year.

The Fed has multiplied existing money more than tenfold since 2008 and assured there would be no consequences. When inflation arrived, it went into denial and changed the target rules. Then he promised that inflation was transitory — remember Powell’s infamous speech at Jackson Hole last year. Then he said he would act at some point. Only now has it made it clear that it will take its role of controlling inflation seriously. But he still hasn’t apologized either for the huge mistakes of the recent past, or for the repeated mistakes in projecting scenarios.

And Brazil? Fortunately, we are not weakened as in times past. The BC has US$ 350 billion in reserves, foreign direct investment exceeds the current account deficit (about US$ 60 billion against US$ 25 billion), and the Selic has been above inflation for several months, a rare exception worldwide. It is a much more advantageous situation than Turkey, Chile, Colombia and Indonesia, which are fragile in terms of international flows and reserve coverage.

Milton Friedman agrees with the Austrian School that central banks do more harm than good. In his lecture on receiving the Nobel Prize in 1976, he pertinently stated that central banks could be replaced, with gains for all, by computers that would guarantee 3% growth in the monetary base per year. I got a good idea.