Brazilian debt lessons for the United States

U.S. policymakers should pay close attention to how Brazil goes about resolving its public debt problem. Despite a number of major differences between the U.S. and Brazilian economies, they share the basic problem of having unsustainable public finances. Brazil being very much closer to a public debt crisis than the United States, U.S. policymakers might draw valuable and timely lessons from the Brazilian experience to come up with a strategy to address our own public debt problem.

Among the striking similarities between the U.S. and Brazilian economies right now is the dire state of their public finances. Both countries are experiencing budget deficits of between 13 and 15 percent of GDP, and both countries now have public debts that are well on the road to exceeding 100 percent of GDP. 

Both economies have also been very hard hit by the COVID-19 pandemic. Yet both countries have the dubious distinction of still lacking a coherent strategy to address the pandemic. In addition, both countries are now experiencing currency weakness, although the currency weakness in Brazil is very much more pronounced than that in the United States.

In principle, like the United States, Brazil has essentially four options, or a combination thereof, to deal with its public debt problem. The most desirable option would be to try to grow its way out of its debt problem as the U.S. managed to do after the Second World War. The least desirable option would be to resort to very high inflation as a means of inflating away the debt as Brazil has done on numerous previous occasions with a very high social and economic cost. 

In between going for growth and resorting to inflation to deal with the debt problem, one option would be to engage in financial repression to keep interest rates artificially low for a prolonged period of time, even though this might be damaging for the country’s long-term growth prospects. Alternatively, since most of both countries’ public debts are in local currency and are domestically owned, there is the ever-politically difficult option of debt restructuring.  

For a country to grow its way out from under its public debt mountain, not only does it need rapid economic growth, it also needs to have a relatively small budget deficit and reasonably low interest rates. 

Unfortunately, with a primary budget deficit of well over 10 percent of GDP and with interest rate policy likely to be soon needed to arrest the present free fall in Brazil’s currency, it would seem that a continuously high budget deficit and rising interest rates will keep Brazil’s public debt on an unsustainable path. At the same time, Brazilian economic growth is likely to remain very subdued so long as there is political uncertainty and a lack of control over the coronavirus pandemic as well as the need to engage in budget austerity.

Nevertheless, Brazil appears to be in a much better position than it was some 10 years ago to restructure its public debt. Not only is the bulk of that debt denominated in local currency and subject to Brazilian jurisdiction, it is also mainly domestically owned. 

A justification for Brazil going the debt restructuring route would be that, at 100 percent of GDP, Brazil’s public debt is far too high for an emerging market economy if it is to grow at a reasonable rate. While going the debt restructuring route will almost certainly encounter strong political resistance, it would seem to be clearly preferable to going the inflation route. 

Since the start of this year, Brazil has had among the world’s worst performing currencies. Over a period during which the U.S. dollar lost around 10 percent in value, the Brazilian real has managed to depreciate by around 30 percent against the dollar. The Brazilian currency’s plunge should be a wakeup call to Brazilian economic policymakers that in the absence of a coherent policy to deal with its public finance problem, the Brazilian inflation genie could once again be released from its bottle. 

In the likely event that Brazilian policy inaction will soon lead to a currency crisis and a renewed bout of inflation, at least it might be useful in one respect. It might help put to rest the dangerous claims being made by proponents of Modern Monetary Theory that high budget deficits and rising public debt levels do not have serious adverse economic consequences.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney. John Kearns is a research assistant at the American Enterprise Institute.