Thoughts on Brazil’s latest FX intervention

The Brazilian central bank today announced they will increase reserve requirements on commercial bank speculators trading the short side of the USD.  It means it will effectively make it more expensive to short the USD.  It will do this to keep its own currency, the real, weak at the margin.

The Real

Really what we wanted to comment on here is how ludicrous a plan this is.  This is a completely localised issue and cannot weaken the BRL against the USD over the long run, as both these currencies trade in many more markets and on many more crosses than only the Brazilian one.  It will bring about a stickiness in the downward adjustment of the USD-BRL cross that will not happen on other crosses.  Which means arbitrageurs must be smiling because the market will be less efficient providing them with more opportunity for profit.  Furthermore, Brazilian speculators can just trade the market through their offshore account where these regulations don’t apply.

This is one point.  The second is that speculators account for only a small portion of the entire market trading USD and BRL. The majority of people trading USD and BRL are everyday Brazilians and Americans using these currencies in their everyday lives.  Speculators just help to bring about a more expedient adjustment in the value of currencies.  The root cause of USD weakness are gargantuan fiscal deficits, trillions of dollars worth of money printing, and zero percent interest rates.  As long these policies continue the USD will weaken.

Just some months ago the Brazilians imposed taxes on foreign capital inflows which it initially thought was a good idea.  However, this pushed the cost of transacting in Brazilian bonds up so much that foreigners left the market.  Liquidity dropped, and the Brazilian government couldn’t find lenders.  It was a total flop.

This policy will not stop the rise of the real.  It will only make the rise more choppy. Soon, the Brazilian government will be forced to bring out the printing press, the most effective and only tool for devaluation.