Poor Ambassador Elbrick.
Imagine how he felt on September 4, 1969… when a group of leftists burst in on him in Rio de Janeiro and took him prisoner. Revolutionary thunderclaps were being heard all over South America. Charles Elbrick must have wondered if he would be struck by lightning.
But the revolutionaries who took him into custody were not crazy. They had rational expectations. And in the event, three days later, he was released in exchange for a dozen leftists from Brazil’s jails.
‘Being an ambassador is not always a bed of roses,‘ he remarked, after regaining his freedom.
Brazil has made its share of bad decisions…and suffered its share of bad policies. Generals, dictators, repression, depression and hyperinflation – Brazil has seen it all. In the 1980s, Brazil’s consumer price increases went wild. In constant currency, a taxi ride that might have cost 4 cruzeiros in 1980 would have cost 5 trillion cruzeiros in 1994.
In the meantime, the government tried to head off inflation by introducing a new currency, the cruzado. Then came the new cruzado. Then the cruzeiro came back. And finally, the real.
‘It wasn’t quite as bad as it sounds,‘ explained a colleague here in Sao Paulo. ‘The government tried to neutralize inflation by indexing prices to inflation. So, people were not wiped out as fast as you would think.‘
But with prices rising so rapidly, it was impossible for investors and business people to make reasonable projections. The economists’ phrase ‘rational expectations’ had no meaning in a world where nothing seemed rational at all.
Naturally, investment and output suffered…as government spending continued to grow. How could the Brazilian feds finance their old programs – let alone new ones – when the real economy was shrinking? They printed more money!
What is most interesting about this from our point of view is that the government did not massively increase the money supply to set off hyperinflation. It merely covered its deficits. In the late ’70s, Brazil’s economy seemed to be doing well.
The only hitch was that the government was spending twice as much money as it raised in taxes. Economists were surprised when prices began rising sharply. Then, inflation forced the government to print much more money to cover much bigger deficits. And finally, it was printing up new pieces of paper with lots of zeros on them.
Note to readers: hyperinflation isn’t necessarily the result of huge increases in the money supply. It is as much the cause of money-printing as the result of it. People fear inflation. They spend their money rather than save it. The velocity of money takes off. Prices rise. They dump their currency even faster. Then, the feds have to print more money to keep up with it.
But that was then. This is now. Inflation rates came down after 1994. The economy not only recovered, it took off! Now, it’s the world’s 5th largest…and if what we see in Sao Paulo is any indication, there’s a lot more to come.
Still, our old friend, Doug Casey, reckons you should think twice before buying equities in Brazil:
‘Around 400 companies are listed on Brazil’s main exchange, the Bovespa, for about US$1.2 trillion of market cap. By far the biggest are iron-miner Vale and Petrobras, the national, state- controlled oil company.
‘Those two and 27 other Brazilian stocks are traded in the US. They’ve historically always traded at a discount to their foreign peers because of the country’s well-known problems – high taxes, intense bureaucracy, onerous import restrictions and duties, high crime rate, uneducated population and sub-par infrastructure.
‘As well as Brazil has done, it’s been a laggard by comparison to its peers in Latin America. In the last 10 years, corporate earnings in Latin America have grown on average by 18% annually. The countries that have recorded the highest earnings growth rates are Peru (28%), Colombia (23%), Chile (13%) and Mexico (12%). Brazil trails the list with 11% growth. During that time, Latin American stocks averaged a 10-to-1 P/E ratio. Most expensive (but deservedly so, as by far the most liberal economy in the region) was Chile at 15, followed by Mexico, Colombia and Peru with P/Es of 12. Brazil has historically traded cheaper, with an average P/E of 8. I attribute that to the country’s tax and regulatory structure.
‘According to the World Bank’s "Doing Business" 2011 report, Brazil is ranked 127th out of 183 countries for business friendliness. Mexico ranks 35th and Chile 43rd. Brazil scores particularly badly in categories related to starting a business, registering property, paying taxes and closing a business. It’s Kafkaesque here, as in many other Third World countries, in that they make it nearly impossible to open a business…
‘Based on all of this, I can’t see buying Brazilian stocks.‘
‘Vale,‘ said our man in Sao Paulo, not disagreeing with Doug entirely…but finding what he believes is a diamond among the road gravel:
‘We’re bearish on Brazilian equities too. But we like Vale. It’s selling at only 7 times earnings. And you get a 5% yield. You can’t beat that.‘
Vale is, of course, a large commodity producer. Commodities are out of favour and so are the companies that dig them out of the ground. Commodities are also extremely cyclical. So, an investor could reasonably hope that a turnaround in the commodities market – which must happen someday – will lead to a hike in Vale’s price. He might also not care. As long as the yield holds up, he may be perfectly happy no matter what storms roll over the share price.
Or, he might get struck by lightning.
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