Currency War: The Next Battle

In Brazil, the hot topic continues to be the strong BRL vs the USD - even after a formula one weekend, a new president and creaking infrastructure.

Prior to the G20 Summit, The Exchange War has become a commonplace buzzword in the economic and business press, and is creeping into the common news.

In Exame, a business magazine, "weapons" in the currency war are being prepared by the Brazilian government including even higher duty rates for capital inflows (today at 6%) and charging capital gains taxes from foreign investors (a ghost of the past). But all these weapons are currently on hold until after the G20 meeting in Seoul. Keep your eyes open...

We do not want your money

The Economist, Oct 14, 2010

Last week's The Economist claimed, in its Big Max Index, that the BRL is overvalued by over 40% vs the USD. While this is only one of many indexes, many in Brazil (as elsewhere) are talking about a new currency war.

Fact is, that the Real has gained much value against the USD and EUR over the past years, and is approaching (or is at) the all-time high of 2008 (before it plummeted and made holidays in Brazil a bargain for foreigners... for a while).

The Brazilian government has now responded, afraid that a further appreciation will hurt Brazilian competitiveness, and has raised the IOF (Financial Operations Tax) for foreign capital inflows for fixed capital investments for the second time this month to a staggering 6%. This is to keep "predatory investors" out of the Brazilian market, which has some of the highest interest rates in the world.

In fact, the rates are very attractive: A short-term fixed capital investment will easily give a post-tax return of over 6% p.a. - with local inflation around 5% this is still pretty attractive... if you assume FX-rates will remain stable.

Guido Mantega, the finance minister is afraid of this currency bubble... he should also start looking at a few other bubbles, most notably the housing market in São Paulo...