The Eclectic Economist

The Eclectic Economist

What is Brazilian President Dilma Rousseff’s real crime?

Rousseff faces her biggest trial. Adriano Machado/Reuters

Dilma Rousseff, Brazil’s first female president, is about to go on trial. She is temporarily suspended from office while Brazilian politicians debate whether she broke the country’s laws.

Her crime is she allegedly borrowed about US$11 billion from Brazil’s state banks – about one percent of GDP – to fund long-running social programs for small farmers and the poor while trying to get reelected, which concealed a budget deficit.

The impeachment hearings come amid a wide-ranging corruption scandal and an economy that is in tatters. Rousseff is calling it a coup and urging her supporters to march in the streets.

So why is it a crime for the Brazilian president to borrow money from one part of the government – state-owned banks – in order to allow the executive branch to spend more? The answer lies in Brazil’s history of debt and hyperinflation.

Brazil’s debt problem

Brazil’s constitution expressly forbids spending money that has not been allocated in the budget and also forbids the government from borrowing money without prior authorization.

Other countries have similar clauses. The U.S. Constitution, for example, gives only Congress, not the president, the power to borrow money, and the amount that can be borrowed is subject to a debt ceiling (which isn’t in the Constitution). But beyond that, the document sets no specific limits.

So why does a country like Brazil enshrine in its constitution such strict limits on borrowing and spending? The simple reason is that Brazil has had a very troubled financial history. Past governments have borrowed too much and then been unable to pay off the country’s debts.

Since 1824, Brazil has defaulted on its debts seven times. In roughly one-quarter of all years since 1824, the Brazilian government was either in default or working on restructuring its loans. If Brazil were a person who lived for two centuries, she would have spent about one out of every four years of her life dealing with upset creditors, bill collectors and bankers!

When a country defaults on its debt, it is often shut out of international credit markets. This means that the defaulting country is not able to borrow money.

Argentina, Brazil’s neighbor, last defaulted on its debt in 2001. Argentina was shut out of borrowing from international credit markets for 15 years while dealing with bondholders. It was only able to borrow again starting this past April.

Covering a shortfall

Of course, many governments spend more than they take in as revenue. If a government has this kind of shortfall, there are primarily four methods of handling the situation.

First, the government can cut back on spending so that the books become balanced. Rousseff did reduce government spending after becoming Brazil’s president, but this occurred well after the alleged borrowing. A second way is to increase taxes, fees and licenses so that the government brings in more revenue. This is harder to do because it’s naturally not very popular with voters.

A third way of handling a budgetary shortfall is to borrow money either from locals or people outside the country. This is what Rousseff allegedly did.

Throughout history numerous governments have wanted to spend more money than they take in but for one reason or another were not able to effectively tax their citizens, cut back on spending or borrow money.

That leads to a fourth solution, one that many countries including Brazil have resorted to: print money. This can fund spending in the short term, but in the long run it risks putting the country through hyperinflation – and arguably, this is a worse way to cover a shortfall than borrowing money.

The scourge of inflation

World Bank data show that in 1993, when Brazil’s government deficit was about seven percent of GDP, inflation was over 1,900 percent. The following year, when the country again ran large government deficits, citizens experienced approximately a 2,100 percent annual inflation rate. Two thousand percent annual inflation means items purchased at the beginning of the year cost 20 times more by year’s end.

This kind of inflation robs citizens of their ability to spend money. In countries with high inflation, holding cash, even overnight, can be extremely costly. For example, when an economy has just a 70 percent annual inflation rate, holding cash for seven days means losing about 1 percent of that cash’s value.

As a result, many businesses and people quickly learn that they must keep all cash balances in the bank – even if they plan to use it the next day – to earn interest and avoid inflation destroying the money’s value. Nevertheless, avoiding this wealth destruction is impossible for people who work in restaurants, bars, clubs, theaters and businesses that remain open after banks close.

Inflation of the magnitude Brazil saw in the early 1990s is very similar to theft. It is like theft because high inflation steals the value of a person’s money and leaves people less able to make purchases.

Brazil has tried numerous methods to prevent the government from overspending. For example, it has a special organization called the Federal Court of Accounts, which audits all government spending. The current crisis was triggered when this organization rejected the government’s accounting for the first time since 1937, setting legal grounds for impeachment.

So did Rousseff in fact violate the law? Other Brazilian legislators will determine that at her trial over the next few months.

What is especially interesting to me, however, is that while Rousseff is charged with breaking laws that are designed to prevent inflation, her alleged misdeeds did not cause inflation to spiral out of control. During her presidency Brazil’s inflation rate has been less than 11 percent a year.

Helicopter money

At the same time she is charged with these crimes, leading newspapers like the Wall Street Journal and magazines like the Economist are suggesting that other countries like Japan and areas like Europe should immediately enact “Helicopter Money” policies.

This bizarre sounding phrase simply means that governments should borrow money from their central banks and use the borrowed money to fund extra government spending, without plans to pay the money back. These articles suggest that political leaders in other countries should enact policies similar to what Rousseff is charged with employing!

Whatever the outcome of Brazil’s impeachment trial, it is doubtful that any Japanese or European leader who enacts the similar policies as Rousseff is charged with using will get impeached. Instead, they might be hailed as an economic savior.

This all makes one wonder, what is really the crime that Rousseff committed?