The global imbalances continue to grow and the reactions to those imbalances is nothing short of madness.

As a case in point, Brazil Charges Tax on Bets Against Dollar as Real Rallies to 12-Year High.

Brazil imposed a tax on bets against the U.S. dollar and warned it may boost intervention in the nation’s derivatives market in a bid to weaken a currency that reached a 12-year high this week.

As part of a new round of currency measures unveiled today, the government levied a 1 percent tax on short dollar positions in the country’s futures market above $10 million in notional value. The government may increase the tax up to 25 percent if needed, according to the decree signed by President Dilma Rousseff and published today in the Official Gazette.

Finance Minister Guido Mantega said that the measures give the government a “bigger arsenal” of tools to defend itself from “speculation” that the real will continue to rally amid global economic uncertainty. “We’re reducing the advantages enjoyed by speculators, and we expect the real will weaken or stop appreciating,” Mantega told reporters in Brasilia.

The measures, the latest attempt by policy makers to ease capital inflows behind a 48 percent rally in the real since the end of 2008, are unlikely to reduce the attractiveness of Latin America’s biggest economy to foreign investors, said Jankiel Santos, chief economist for Espirito Santo Investment Bank in Sao Paulo.

Investment is pouring into Brazil as the nation develops offshore oil finds and prepares to host the 2014 World Cup and 2016 Summer Olympics. Foreign direct investment jumped to a record $69 billion in the 12 months through June, the central bank said yesterday.

Today’s measures, while applicable to all investors, will primarily affect foreign investors who hold the bulk of about $25 billion in bets against the dollar on Sao Paulo’s future exchange, said Nelson Barbosa, executive secretary at the Finance Ministry.

Brazil’s Currency Regulation Knocks Real Off 12-Year Highs

The Wall Street Journal reports Brazil’s Currency Regulation Knocks Real Off 12-Year Highs

Brazil’s currency slumped Wednesday as the Brazilian government introduced harsh controls on currency derivatives, knocking the real off 12-year highs against the U.S. dollar.

The real has gained 7% against the greenback so far in 2011, and has advanced about 20% over the past two years. The strong real undercuts manufacturers and exporters, which struggle to compete with cheaper alternatives both at home and abroad.

Some analysts and economists also question whether the latest measures will once again prove unable to stem the real’s rise, given the inherent weakness in the dollar because of the ongoing U.S. debate over spending cuts and raising the debt ceiling. Europe’s difficulties with sluggish economic growth and heavy debt loads also have weighed on the euro in recent weeks.

“If the [Brazilian real] is strengthening versus the [U.S. dollar] because of the perception of adverse developments in the U.S., there is little that the Brazilian government can do other than implement measures that will increase domestic competitiveness,” Goldman Sachs said in a report. Such items could include reducing local tax burdens and productivity-enhancing reforms, the firm said. The full impact of the measures is unclear right now, especially given that they will likely be followed by others, Goldman Sachs added.

Credit Crisis Brazil Revisited

I am sticking with analysis as posted in Credit Crisis in Brazil: Consumer Loan Rates Hit 47%, Defaults Soar, Debt Service Tops 50% of Disposable Income

Reader Otavio, from Brazil writes …

Hello Mish

Otavio here, a Brazilian follower of your blog. Today I want to express my satisfaction as I read you latest post entitled Preposterous Statements – Jim Rogers: “No Food at Any Price”; Barton Biggs: ” U.S. Needs Massive Infrastructure Program”.

When I hear statements like these, it feels like the move up in commodity prices might be near the end. I cannot stress more the fact that high prices fueled by zero interest rates in developed and many emerging markets (for many years now) are a fruit of rampant speculation.

We have our own credit bubble here, which in my opinion has a good chance of busting sooner rather than later, via one or more of the following:

  1. Central Bank over-tightening local rates
  2. Slowdown in China, which would change our terms of trade and contract global capital flows to EM and Brazil (as we are suppliers of commodities to China), tightening monetary conditions here as a result
  3. Deterioration of credit crisis in Europe (and US), would also contract global capital flows and tighten monetary conditions here

I took the liberty of forwarding you a FT article about Brazil.

I think you might appreciate this as maybe a topic for future posts of yours, since you are keen in identifying and warning readers and investors of potential bubbles around the world that may be close to busting. For the record, I will say that in my opinion, Brazilian real estate, many local stocks, and our currency (the Real), are extremely overvalued as well.


With thanks to Otavio, please consider a few highlights from the Financial Times article Brazil risks tumbling from boom to bust

Cash Flow Burden Astronomical and Rising

  • Average rate of interest on consumer loans 47%, up from 41% in 2010
  • Consumer debt service burden was 24 per cent of disposable income in 2010, slated to rise to 28 per cent in 2011. This compares with 16% for an “overburdened” US consumer and a mid-single digit reading for other emerging markets such as China and India.
  • Debt service burden for the so-called “middle class” in Brazil has now breached 50% of disposable income
  • Delinquencies in Brazil (defaults in excess of 15 days) have begun to move up rapidly, from 7.8 per cent to 9.1 per cent of total loans between December 2010 and May 2011.
  • Delinquencies are now rising at a very hectic rate. They have risen at 23 per cent in the first five months of this year in absolute terms or at an annualised rate of 55 per cent.
  • Normally credit indicators cyclically lag the economic cycle. When they begin to deteriorate before any economic weakness it usually represents a structural problem relating to underlying cash flow or underwriting weakness in the quality of credit – Brazil has both problems.

FDI Will Reverse, Real Overvalued

My comment at the time : I am inclined to agree with Otavio who says the Real is “extremely overvalued”.

I see no reason to change my stance now.

It’s important to realize Brazil is not a passive victim. Inflation is rampant and government spending is a “whopping 40 percent of gross domestic product” according to Alberto Ramos, Latin America economist at Goldman Sachs in New York, as noted in Guido Mantega Mulls New Currency Measures

At some point FDI and hedge fund bets on the Real will reverse in a spectacular way. I suspect it will be when China slows taking commodity prices with it. However, reversals can happen at any time.

Certainly the situation is unstable, much like it was with the the Icelandic Krona before Iceland imploded.

Mike “Mish” Shedlock
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