On Doug's WBAI program a couple of weeks ago, he interviewed a very interesting Brazilian economist (whose name Doug pronounced so authentically I couldn't make it out :-) He spoke in passing about the "sterilization" of incoming capital flows, and I'd like very much to understand how it this works, since it seems to contain the most concise and damning indictment of submerging markets I've ever heard. If I understood correctly, Brazil's policy was to maintain a stable, and soon over-valued, Real through its peg to the dollar largely in order to attract large amounts of foreign capital into the country. But, once those capital flows arrived (in the 100's of billions of dollars), the government was *forced* to borrow in order to "sterilize them" -- because if they hadn't issued domestic bonds, the inflow of capital would have undercut the very policies that had brought it in. So in the end they have 100's of billions of short term domestic debt to balance out the inflow of 100's of billions of foreign capital -- and when the capital leaves, they are left with the debt, debt they didn't have in the first place. And now that everyone, including the IMF and the World Bank seems to allow that huge amounts of short term debt is bad for a country, this really does seem to be a huge con game that hides in plain sight. (I think Stanley Fischer said in _The Economist_ that it was specifically short-term debt denominated in dollars that he worried about, but in a dollar-pegged currency, it's pretty much the same thing, isn't it?) The bargain of international capital seems like the financial equivalent of the first free shot of heroin. And it seems especially damning in Brazil, since international capital mongers all seem to agree that Cardoso did everything "correctly" on the financial policy front.
Have I got this part right? If so, how do mainstream economists defend such a system as if it brought advantages?
I still might be a little fuzzy on why sterilization is necessary and how it functions. Doug explained afterwards that this huge influx of money causes inflation, and has to be "soaked up" by the issuance of bonds denominated in the local currency. So the issuance of bonds contracts the money supply? That's seems conventional enough. Does contracting the money supply always rack up government debt? I guess I never thought it about it that way before. How come this normal means of policy doesn't hurt rich countries? Is the only difference that in third world countries (a) the amount of countervailing contraction that is necessary is so huge, (b), it only goes one way -- they never get to expand the money supply and (c) they have to issue short-term debt, rather than 30 year debt, because that's all the world will offer them? Is restructuring a means of getting banks to accept the long-term debt they wouldn't in the first place?
The Brazilian economist Doug was interviewing seemed to be saying that the inflow of capital bid the currency up, and drove interest rates down. But that doesn't seem to be something that would need to be sterilized -- it seems rather that you could maintain the same exchange rate you were aiming for with lower interest rates, which sounds more of a good thing. And it doesn't seem reconcilable with any part of Doug's explanation. Although it might just be that the Brazilian economist sometimes said "increase" when he meant "decrease" -- a understandable problem when a man is trying to describe his life's work over the phone in a language he has to concentrate to speak in.
Any and all suggestions, explanations, and references to papers that might explain these matters would be greatly appreciated.
Michael
__________________________________________________________________________ Michael Pollak................New York City..............mpollak at panix.com