Occupy Brazil

With European banks repatriating funds from their overseas investments, emerging economies such as Brazil have been left to their own devices to attract alternative sources of funding from elsewhere, hence a recent Brazil Summit in New York on April 23, 2012.  Just what Brazil was asking from the Big Apple’s investment community is not exactly clear and for the most part reminded me of the infamous Occupy Wall Street movements where the overall message lacked focus.  However, there was a striking difference.  

‘Occupying Brazil’ is not about a 1% wealth disparity but rather a living success story of wealth distribution where, in contrast, 55% of the Brazilian population today are considered part of the middle class. According to Brazilian experts, over 46 million consumers qualify as recent entrants and are ready and able to buy beyond the basics.  Companies selling furniture, electronics, autos, and more are lining up with good reason to earn a piece of this burgeoning market.  Unfortunately, the onslaught of companies has introduced a new set of problems, namely, where to accommodate everyone including their offices and how to transport them around efficiently throughout each city.

Brazil’s infrastructure, which includes its roads and highways is at the heart of both its greatest success and its most severe problems.  A 45 minute drive to Sao Paolo’s airport often becomes a 5 hour ride with only minutes to spare to catch an international flight.  Having too many cars circulating through poorly maintained roads is costing the Brazilian economy billions in lost productivity.  Fortunately the government is  aware and is aggressively seeking innovative solutions to address these and other pressing issues.

Even though Brazil is considered a developing country, Brazilian leadership is not to be underestimated.  Henrique de Campos Merirelles, a former Brazilian central banker and known for his poker-face style, won the highly coveted prize of hosting the 2016 Olympic summer games against a formidable slate of candidates, which included Madrid, Tokyo, and Chicago.  Equally as impressive, Brazil will host the 2014 World Cup Soccer games for a combined investment bonanza estimated at USD$53b.  Other milestone achievements include a $225b capital investment for extracting 95 billion barrels of pre-salt oil reserves located miles under the ocean.  These type of herculean investments have helped Brazil become the sixth largest global economy with a GDP of $2.5 trillion, surpassing the United Kingdom.  By comparison, the USA is the largest economy at $15.1T followed by a distant China (but growing rapidly) at $7.3T.

How will Brazil host two world class games, accommodate a vibrant and growing middle class, monetize its oil reserves, and maintain a sustainable economy for decades to come?

If you ask Guido Mantega, Brazil’s Finance Minister, he will undoubtedly point to lower interest rates and longer term debt.  But despite his assessment to solve his country’s problems, Mr. Mantega and other well-trained government officials are log jammed in a political quagmire among themselves, which in an uncanny way resembles the notorious traffic congestions on Brazilian streets.  Similar to vehicles sitting in traffic, the many ideas and suggestions from Brazilian officials are getting caught up in an antiquated political system that, like its roads, needs to be redesigned and overhauled.

Is there a Danger of Runaway Inflation?
Some experts fear that the increasing demand for goods and services in Brazil will overheat its economy and potentially trigger runaway inflation; however, a closer look at the numbers shows that nothing could be further from the truth.  Just recently Brazil reduced its interest rates to 9%, a level considered high by global standards but, when evaluated with other extenuating factors, falls in line with the norm.  First, not every loan in Brazil is treated equally.  For example, local industries can get access to subsidized rates that are closer to 1% through its national development bank, BNDES.  Banks loaning at 9% to consumers are borrowing at 1% and using a portion of their profits to support government-backed savings accounts that offer tax-free annual interest of 6.17% to consumers.  With an inflation rate of around 5%, Brazil is actually operating within the real interest rate range of other global economies.

Is there a Danger of a Real Estate Bubble?
According to the World Bank, Brazil would need an annual growth rate of 10% for the next 10 years, just to meet its growing demand.  Today Brazil’s GDP growth rate is fluctuating between 4 and 5%.  On its own, Brazil clearly cannot meet its soaring demand.  For example, Brazil’s annual growth of 4% for its roads and highway projects matches the 4 to 5% annual expenditures needed to maintain existing structures.  In essence, Brazil’s roads and highway infrastructure is experiencing zero growth on a net basis.  Another example is in real estate.  As long as developers continue building for current rather than future demand, a real estate bubble could never form.

However, not all is rosy for Brazil.  Without the efficient injection of long term affordable debt funding, the economy could stall.  Demand for goods and services from an onslaught of global consumers could force prices to rise causing havoc for the newly minted middle class who will demand more from their politicians and become adamant to vital social and economic changes.  Why then has Brazil not experienced economic collapse due to runaway inflation?  Part of the reason may be attributed to Brazil’s uncanny ability to foresee its own future in a manner that no global index has been able to capture.  I like to refer to this stealth trait as ‘Brazilian foresight’.

Brazilian Foresight
To appreciate the power behind ‘Brazil’s foresight’, one should ask two key questions:

Q1. Was it not Brazil who 40 years ago decided after the oil embargo during the Carter years to launch a biofuels industry that today provides the country with unprecedented energy independence?
Q2. Was it not Brazil that after pegging its currency to the dollar to control inflation, reverted back to its local currency, the Real, to regain its economic independence by shifting from local consumption to an export-led economy?

Truly, if an index for foresight were established, Brazil would be ranked among the top five!  A follow-up question might be, “Is the influence of ‘Brazilian foresight’ present today?”  Perhaps.

Traces of ‘Brazilian foresight’ emerged from the recent Brazilian Summit organized by the Brazilian Chamber of Commerce and held at the Harvard Club of New York.  Brazilian panelists who addressed the pressing need for cheap long-term loans, discussed an alternative financial arrangement known as public-private partnerships or PPP’s.  These complex arrangements between the public and private sectors combine strategic companies with a combination of government concessions and long term revenues.  A recent example is a soccer stadium that will be used for both the World Cup and the Olympics.  The 33-year deal involves the government and a group of strategic private companies whose expertise is expected to reduce investment risk and ensure a viable return over the long term.

Another trace of ‘Brazilian foresight’ was a recent bilateral agreement between Presidents Rousseff and Obama.  As part of a program called ‘Innovation in Sciences’, 100,000 Brazilian students will be sent abroad on full-paid scholarships to earn their Masters or Doctorate degrees at academic institutions worldwide.  Half are expected to attend US universities including Harvard and MIT.  This bold initiative will move Brazilian presence at prominent US universities along side 160k Chinese students, 100k Indian, and 70k South Koreans who are already present.  The Brazilian government hopes to entice their returning graduates to to fill the 900k engineering positions expected to open by 2020 in the IT industry alone.

Proposed Solutions
Clearly Brazil’s future will depend upon its ability to attract low interest, long-term debt.  But with political time horizons that seek short term victories, one might expect Brazil’s President Rousseff to decouple long-term debt financing initiatives with current politics.  For starters, floating a 3 billion Real 40-year sovereign bond at a low rate would not only send a strong message to the international investment community but also help investors set rates for their own projects.

Taking into consideration the potential foresight of Brazilians, one can only expect that both reason and smart solutions will eventually prevail.  Outside investors should take note, if indeed, they intend to some day ‘Occupy Brazil’.

Inflation vs Debt Forgiveness

As the rich get richer and the poor become poorer, the global middle class, the ballast of an economy, is fading away rapidly!  Will history repeat itself with another global recession? …or will technological equalizers instigate radically different outcomes similar to the Arab Spring? 

2012 will launch under an uncertain backdrop due to a slew of upcoming political elections in major economies. The newly elected officials will inherit an inefficient global economic system burdened with debt that under the best of circumstances may take several decades to repay. Without the presence of a strong middle class, however, the lack of sufficient funds to service global debt load could threaten public sector payrolls and hence the key supply of political votes. As long as the global economic model remains unchanged, an era of international debt forgiveness will precede any major political changes.  Just as home-owners have walked away from mortgages greater than the value of their homes, so to will indebted countries force their creditors to take significant write-downs.  Eventually the global economic system will collapse under its own weight as lenders and shareholders to affected banks miss their interest payments too.

This dire scenario, likely or not, should help readers see through the clutter of political rhetoric and appreciate the incredible importance of supporting a healthy middle class.  For example, a strong middle class offers the tax collection engine to pay down debts by training and employing a workforce that sustains local and export-based industries. It also keeps the wealthy in check by allowing new entrants and keep the poor in line to become law abiding citizens and contributors.

What chance does the middle class have in today’s political climate?  Consider North Korea where a family’s militant rule has mesmerized the population into a fanatical frenzy unaffected by the usual stimulants of change such as starvation or border profits.  …or Venezuela where political loyalties are exchanged for basic needs.  …or China where a centralized ruling party dictates price levels and exchange rates.  …or Russia where cronyism and mafias undermine social freedom.  …or Spain where the unemployment rate of young professionals is rampant.  …or Pakistan where the military and the ruling party are at a ‘Mexican Standoff’.  …or Iraq where the US military exodus may soon result in a civil war.  …or Greece where the ECB plans to establish local branches to attract local funds, hence eroding any chance of a middle class comeback any time soon.

Under these real world circumstances, any middle class would have a tough time thriving.  What then can be done, when the cost of servicing debt undermines innovation, growth, and progress? How likely will a wired middle class hold out for two decades longer to make good on their debts?  No doubt something will give in, sooner than later. Will it be inflation, debt forgiveness, or both?

Modernizing the Euro

As Merkel and Sarkozy raise the poker stakes for a more stable euro, international bankers are folding. The combination of heavy laden debt with a crisis of confidence is proving unsustainable. Could or should the euro survive?

The principal pillars supporting the euro are buckling under the weight of unsustainable debt from their weakest members.  Countries such as Greece, Italy, and Spain are faced with a near impossible task of competing against members with more efficient economies.  They are also borrowing funds in a common/strong currency (euros) at significantly higher interest rates than their northern brethren.  Without the ability to devalue their currency to instigate export growth, these less efficient economies will only become weaker not stronger.

Based on lender stipulations, primarily from German sources, debt laden countries must convince their voters to accept lower wages and pay higher prices.  Understandably, elected leaders from both sides worry about inciting social unrest and potentially losing their own jobs.  They are also concerned of losing their best and brightest workers to better paying jobs elsewhere, a serious situation that could potentially impact their future generations of indigenous leaders.

Some industry experts suggest the creation of a federalized central banking authority that would be accountable for the aggregate interest of all member countries.  As it stands today, the decision makers responsible for the euro’s survival are only accountable to their own local voters and have no incentive to consider a common solution.  As though apathy was not enough of a deterrent for progress, EC voting representation is also lopsided.  Rather than being slated by population size, decisions are voted upon by membership, hence, a vote cast by the island of Cyprus is equivalent to a vote from France.  Other experts suggest giving the ECB (via the IMF) greater authority to buy up depressed bonds from anxious bondholders using freshly minted euros, but the potential inflation caused by printing money and the inevitable interest rate increase that would follow, could trigger a greater recession.

A Viable Solution: In view of the obsolete political infrastructures among members,  European leaders should focus on increasing the valuation of their political currency through radical institutional reforms combined with a moderate devaluation of the euro to help monetize the debt load.  This solution could be achieved by having three different exchange rates for the euro currency that would reflect the level of sovereign debt by each member.  The most devalued rate would be extended to new potential EC members who would early on recognize the authority of a federalized ECB.  This modernized approach would not only strengthen the euro’s survival but also fill its pipeline with better prepared future EC members.

Creating Jobs in America

With so many Americans out of work, what can our government do to turn this ailing ship around?  They’ve tried buying back our own debt twice to keep interest rates low, but businesses aren’t biting.  Why are they so hesitant and what will it take to defrost our frozen economy?

Most people believe that the financial crisis of 2009 was caused by poorly trained mortgage sales people who managed to successfully game the system.  However, did you ever wonder why everyone was a victim of the financial crisis, while no one was really held responsible?  Perhaps the crisis was caused by something far greater than by a few anonymous and unscrupulous bankers.

Since the early 1900‘s our banking system has never really changed much.  Deposit slips, checks, and even loan applications look and read the same.  Compare this stodgy business model of banking with the jet-setting, super-efficient, internet-based business environment that we live in today.  Can you see the difference?  Our slow and antiquated banking would be similar to using a 300 baud modem to surf the web today or racing in the Tour de France with a child’s tricycle. Unheard of, you say… and that is precisely my point.  It was only a matter of time before our economy would collapse due to the disequilibrium created between a rapidly changing business climate and the antiquated financial system used to govern transactions and monitor financial integrity.  Another visual might be a person trying to drive a car while pressing both the accelerator and the brake at the same time!  Either way, the economy or a bumpy car ride, the experience would be less than reassuring.

Similar to banking, the lack of qualified workers is another reason our economy is anemic.  There are plenty of high paying jobs but the majority of our workforce is essentially unemployable.  You can blame the unemployment crisis on overseas outsourcing or outdated training centers, but the solution for creating jobs in America may lie elsewhere.  For example, rather than focus attention on helping small business owners improve individually, through SBA loans or business training classes, policymakers could leverage existing business expertise, especially among investment bankers, to identify international supply chains where US-based small businesses can participate.  The required work would be second nature to a well trained M&A specialist and could help introduce new levels of efficiencies among small business owners, such as from fewer bankruptcies through better business alignments.  It could also be the optimal scenario for more sustainable jobs in America.  Hmmm… Interesting?  
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Gaming Inflation

If the recent jump in your weekly grocery bill has you worried, guess what?  You are not alone.  In response to higher energy costs, food prices have soared due to the rising cost of harvesting crops, processing foods, and transporting ingredients from the field to a neighborhood grocery store.

The same dollar that purchased a gallon of milk, now only buys a quart.  In short, the US dollar today is worth less due to what is commonly referred to as inflation.   What is inflation and what can we do about it?

Inflation can be caused by an increase in demand or an increase in the supply of money used to purchase goods and services.  In a perfect storm a country expanding economically (i.e China) can drive up the prices of key global commodities such as oil, while at the same time have a devastating affect on contracting economies (i.e. USA) that depend on the same oil to survive.  Consumers in the weaker economy (i.e. USA) must depend on their governments to mint additional currency and inject these funds through various mechanisms to help make ends meet in the short term.  Otherwise, the rising cost of fuel and food in a cash-poor local business environment will trigger economic collapse, because consumers will not have enough cash-on-hand to buy what they need to survive.

Minting more dollars to help consumers what they need is the government’s way of a ‘quick fix’, but it can also trigger severe consequences and side-effects to a local economy or system.   First and foremost is the inevitable increase in the supply of dollars throughout the global banking system.  Too many dollars injected into a system will dilute the value of the other dollars based upon their exchange rates with other currencies.  People holding dollar denominated investments will further aggravate the system by unloading their assets to buyers demanding lower prices.  As the dollar sinks in value worldwide, the cost of US imports rises.  Unless these imports can be replaced through local production (or importers are willing to accept lower margins, an unlikely event), prices will inflate.

Inflated prices among a cash-strapped consumer base is perhaps the primary catalyst needed to overhaul a laggard economy.   Key to a successful and sustainable transition is a government’s willingness to promote innovation and efficiency through effective and realistic policies.  As the various economic crises in Europe continue to teach us, printing money or extending loans is a dangerous game that will only result in inflation.  Politicians should evaluate new business models that can easily integrate financial innovations within a rapidly changing geopolitical world.

Warming up to the New US Census Numbers

What does global warming and the new census data for the US population have in common?

Both issues seem to unveil a growing trend where city-dwellers from northern states are heading south.  Colder winters are one reason but another is the changing cultural composition of future Americans.  Increasing number of Hispanics who tend to prefer warmer climates have soared by 43% in the past decade to 51m.  The Asian population has also kept up at a similar rate with 15m, while Blacks have trailed with an 11% growth rate with 38m.  All together the minority groups swelled at a rate of 29% to 112m.  At 197m, Whites continue to hold a slender majority at 54% for those under 18 years of age and at 64% overall.

The changing faces of Americans are starting to look less white and more tan, bronze, olive, and other hues than ever before.  Already minorities from two of our most populated States, California and Texas, outnumber their former majority.  Where this trend is most noteworthy nationally is at the youngest age groups.  For example, 92% of American three-year olds are no longer originating from the traditional White population.  In the next 20 years when these three year olds become the new members of the American workforce, many will look back at 2011 and wonder how a business or political entity could have ever survived without the many proven benefits from a diversified workforce.