São Paulo, 19/11/2008

 
High interest rates and decapitalization of the economy

Ladislau Dowbor
December 2002

The process has become, on the whole, relatively simple. The money you deposit in the Bank, if you have small savings like I do, yields around 10% per year. The Bank uses this money to buy government bonds, presently at 25%. The government, in turn, pays these interests with public funds – that is, with our taxes. Since 25% minus 10% is 15%, we are paying the bank, through the government and with our taxes, 15% annually to take care of our money. Working with the money of others in this way is, for the Bank, really quite gratifying. But the issue here is not this, but rather the practical consequences in terms of the reduction of our economic options.

Of course, remuneration on this scale, over the long term, is unsustainable, since there is not enough taxpayer’s money to cover the growing debt. The debt has reached something like R$ 800 billion (Brazilian GDP is about R$ 1.3 trillion). Not all this debt is financed at 25%, but we have reached a point where the government, even tightening its belt to obtain a surplus if 3.75%, still barely covers one third of the interest, and paying down the principal is out of the question. We are thus in the same boat as so many people who, not being able to pay off a loan, rely on their overdraft protection, then run their credit cards over the limit, and so on.

We are not going to get into the broad discussion about whether this debt is payable or not. What is of interest here is that the system leads the government to divert tens of billions to servicing the debt, and thus fails to provide many public services, which is the reason we pay taxes in the first place. Thus we are not able to improve education, health, research, infrastructure and so forth. And this is not a temporary sacrifice, because by paying only part of the interest, the debt increases.

What happens to the economy? A producer, whether rural or industrial, could go to a bank to finance its business operations. Traditionally, this is what happened. Today, the banker explains that since there is always the alternative of investing in bonds at 25%, it will only make the loan to the producer at 30%. A Fundação GetúlioVargas study, carried out on behalf of FIESP (Federation of Industries), presents this figure as what the   companies paid for working capital in June 2002. Of course, given that producers in Europe and the United States can find financing at around 2-3%, the Brazilian producer is simply not competitive. Not to mention the large number of producers who discover that playing the market is more profitable than producing, and thus shift their investments towards speculative activities. The practical result is economic stagnation. Thus it is more difficult to expand public revenues, which in turn further tightens the noose on government, obliging it to raise interest rates further, or maintain them at the current stratospheric level, to avoid a capital flight.  The noose is thus very secure. 

As a result, the capacity of the State to provide public services and infrastructure is undermined, as is the ability of the producer to expand production. What happens to our municipalities? In part, through Fiscal Responsibility Act, they are contributing to financing the deficit of the federal government. But the process is more serious than this. Some time ago I read the results of a small study carried out in Bertioga, where an analysis was conducted of what happened to the money deposited by residents in local bank branches. The study showed that for every 100 reais deposited, 92 were invested outside of Bertioga. What does this mean? It used to be, only a few decades ago, that a branch manager talked with all the local businesspeople, seeking out opportunities for investment in the region, and thereby supporting local development. Today, the manager is rewarded by points as a function of how much he is able to extract. Once, he was a planter in search of fertile ground. Today, he has become a vacuum cleaner that leaves nothing behind. The result is the loss of countless small initiatives essential to strengthening the economic fabric of the country.

What happens with common citizens, who are neither government, nor businesspeople, nor organizers of local development? They are treated as a client, in the modern sense of the word. First, they don’t choose the bank, because it is assigned by their employer. They are what might be called captive clients. In reality, each company makes a deal with the bank for their quota of future clients. And the client opens an account where the company pays him. This point is very important, since it means that for common mortals, there is really no market competition, and the banks can charge whatever fees or interest they want, with just a glance once in a while at what other banks are doing, to ensure they don’t wander too far from the pack. The practical result appears in a variety of forms, such as figures for “average interest for individuals” of 83%. In my bank, I can write a check to be repaid in installments, with interest of 132%. One bank decided to bring the poor into the banking system, by giving them loans based on simply presenting their employee card, at 166%. As one friend said, some friend of the poor they are … 

Some additional information is starting to appear, even though this greatest scandal of our economy merits more serious research. The results that have appeared recently in various publications show that financial costs consume something like 30% of Brazilian family income. Of course, an important fact here is that retailers have discovered that they can make much more money dealing with money than with products. Because they earn little, the poor can pay little, and are obliged to divide their limited purchasing power into many installments, with interest rates usually 150% upward.

The result is that the population’s capacity for consumption, which is essential to stimulate the country’s economic activities, is weakened, since much of our purchasing power is diverted into payments to financial intermediaries.  Thus the paralysis affects government, productive activities, the dynamic of local development, and the demand incentive that is a key element for the growth of the domestic market. Curiously enough, they call this “stability” and the government that protects this system is said to be “responsible”.     

What is the international dimension of the process?  As we know, much of the debt is held in dollars (in Brazil, roughly 37%). This means that if the dollar rises, the speculators who own this debt will receive more. Poor countries from the so-called third world can’t print foreign currencies. Their only options are to maintain reserves built up through a surplus trade balance (which presupposes that we can overcome the protectionism of the rich countries), attract foreign investments, or obtain more loans on the international market. The greater a country’s needs for foreign currency to balance its accounts, the greater will be the reluctance of the “international financial community” – essentially a group of Wall Street speculators – to lend, except, of course, if the country ensures a very attractive remuneration, which means high interest rates, with all the consequences we have seen above. 

Poor countries have limited reserves. Brazil has reserves in the order of 30 billion dollars, and Argentina has something like 10 billion. For comparisons sake, an average speculator such as Edward Jones manages, according to Business Week, 255 billion dollars, and Merril Lynch something like one trillion dollars. Joseph Stiglitz, Nobel Prize winner in economics in 2001, explains the process in a meridian manner, using the concrete example of an operation in Thailand. A speculator requests a loan of one billion dollars from Thai banks, in local currency. Since it is a large international investor, the local banks are enchanted. With this billion, the speculator buys dollars on the local market. Seeing the dollars disappear from the market, other local bankers and speculators also start buying dollars, with the exchange rate rising sharply. After a time, the speculator resells part of the dollars to pay the local loan, and emerges with a net profit of 400 million dollars for each billion used. He didn’t produce anything, didn’t need to invest one cent of his own, and since the control of capital movements is a mortal sin according to the doctrine that Stiglitz appropriately names “market fundamentalism”, the money leaves the country. The speculator doesn’t need to leave Manhattan.

To protect itself from the attack, the government abruptly raises the basic interest rate, which means it will have to pay huge interest on the internal debt, and not having enough tax money to cover the interest, the debt explodes. It is so easy to convince the so-called international community that the instability was generated by the government’s financial irresponsability. Who is responsible? Usually the international speculators, the government’s financial authorities and local bankers are all active participants. In Stiglitz’s words, “the chance to make money becomes irresistible”. This means that the way the system works is simply wrong, since it keeps money from those who could transform it into productive investment and growth.  

What is the official theory of the International Monetary Fund in the context of these dynamics? “The fundamental benefits of financial globalization are well known—by channeling funds to their most productive uses, it can help developed and developing countries alike achieve higher standards of living.” (Finance & Development, IMF, March 2002, p. 13).

In fact, the contrary is true. It decapitalizes production, the State, communities and the consumer. Since the process implies high interest rates, companies need to self-finance. Thus, the liberalization of capital flows, which should theoretically “channel funds to their most productive uses” leads in fact to the draining of resources for speculative purposes, and increasingly leads companies to pursue self-financing, generating a financial feudalism in which each one seeks self-sufficiency, losing precisely the capacity for the savings of one to support the investments of others. The effect is the exact opposite of what is predicted, or imagined, by the Fund, but rigorously coherent with the interests of speculation, and in fact quite foreseeable.   

In reality, the wealth is drained to the domestic and international speculators. It is important to understand that markets do not function for products where the supply is very limited. Since we don’t control the supply of foreign currency in our markets, we have no power to regulate the process. When a speculator can mobilize hundreds of billions of dollars, and the country has only a few tens of billions, the natural result will be extreme vulnerability. There is truth to the argument that the scale of the international economic interests in Brazil protects us from such a destructive attack as that carried out in Argentina. There is no interest in having our economy collapse. Both domestic and international speculators are only interested in maintaining the current state of things, and continuing to milk for the generous and passive payer that the country has become. We have managed to put in place a highly structured system of draining of savings, restricted consumption, and discouragement of investments, which is paralyzing the country.  This is a dumb system. Everybody, including financial intermediaries, would be better off on the long run if we were allowed to adopt a growth oriented financial system.

We invite the reader to check the numbers for himself:

- Fiesp/Ciesp/FGV – Juros sobre capital de giro: o impacto nos custos da indústria brasileira, final report, April 2002. The study estimates the cost of working capital to companies to be around 30%.

- ANEFAC – Associação Nacional dos Executivos de Finanças, Administração e Contabilidade – (www.vidaeconomica.com.br/familias.htm ) Research carried out between June and August, 2002. According to the study, the average family spending on financial costs is 29.83%. These expenses range from 35.43% for families earning between 1 and 5 times the minimum salary, and 19.08% for families with income above 50 times the minimum salary.  ANEFAC data were published by the magazine Época.

Data on profit levels and the channeling of our savings to government bonds, including by the Banco do Brazil, which had once been a traditional source of financing for productive activities, were published by the newspaper Folha de São Paulo on November 13, 2002, p. B7. It shows, among others, that 83% of the corporations intending to invest in 2003 will not seek credit, but rely on self-funding.

- A clear and transparent explanation of international mechanisms, and how interest rates and exchange rates are manipulated by speculators, can be found on pages 94-95 in Joseph Stiglitz’s book Globalization and its Discontents, 2002, with a Portuguese translation already available in Brazil.

- The traditional view of the FMI, which actively sustains the process analyzed above, can be found in the publication Finance & Development www.imf.org. The March 2002 issue has the advantage of focusing on global finances. 

- There is also interesting information in the publications of ANDIF (National Association of Consumers of the Financial System) – http://www.andif.com.br 

- Regarding our capacity to face the various disequilibria generated – public and private debt, internal-external, in reais and foreign currencies, there is an excellent study by  Alexandre Schwartsman, “No Free Lunch”, aschwartsman@bba.com.br 

- the interest/exchange rate trap in thailand is described in Stiglitz’s bo

I express my thanks for the help of Flavio Liberado in compiling these data. The issue is of interest to all of us. Additional information and comments ares welcome, at the site www.dowbor.org , Mural or by email at ladislau@dowbor.org

Ladislau Dowbor, é doutor em Ciências Econômicas pela Escola Central de Planejamento e Estatística de Varsóvia, professor titular da PUC de São Paulo e da UMESP, e consultor de diversas agências das Nações Unidas. É autor de “A Reprodução Social”, “O Mosaico Partido”, ambos pela editora Vozes, além de “O que Acontece com o Trabalho?” (Ed. Senac) e co-organizador da coletânea  “Economia Social no Brasil“ (ed. Senac) Seus  numerosos trabalhos sobre planejamento econômico e social estão disponíveis no site   http://dowbor.org