Lula's Foreign Policy

 The following is from a email from Foreign Policy magazine:

When former—and now incoming—Brazilian President Luiz Inácio Lula da Silva took to the podium in São Paulo on Sunday night following his razor-thin election victory over incumbent President Jair Bolsonaro, he first stressed that he would govern for all Brazilians. Then he proceeded to speak extensively about foreign policy.

In his recent international travels, Lula said, “What I hear the most is that the world misses Brazil. They miss that sovereign Brazil that talks to the richest and most powerful countries like an equal and at the same time contributes to the development of poorer ones.”

Lula alluded to his role in past efforts to integrate South America and Latin America by strengthening customs union Mercosur and the now-defunct regional organ Unasur; carry out technical cooperation with African countries; and create the BRICS grouping of Brazil, Russia, India, China, and South Africa. Going forward, he pledged to work for fairer international trade, take an active role in fighting the climate crisis, and campaign for including more countries as permanent members of the U.N. Security Council. Brazil has for decades sought a permanent seat on the council.

Celso Amorim, Lula’s foreign minister during his 2003 to 2010 presidency, has often described Lula’s foreign policy of that period as “tall and active”: Brazil opened 35 new embassies and launched new cooperation initiatives with countries including the United States, Iran, and Russia. Amorim remains Lula’s top foreign-policy advisor and stood near him on stage on Sunday; he is expected to continue to advise Lula on foreign policy in the new administration.

But the world has changed dramatically since the two were last in office: Sharp geopolitical tensions between Washington and both China and Russia make Brazil’s previous constellation of alliances more difficult to maintain, and Brasília’s global standing has also diminished dramatically under Bolsonaro. Still, Lula appears set to try to resurrect his wide-ranging foreign policy.

In an early sign of goodwill, Lula received a stream of congratulations from the leaders of countries including the United States, France, and Australia in the minutes after his election victory was confirmed. In at least the U.S. case, Reuters reported that the quick recognition was an effort to stave off any potential attempt by Bolsonaro to contest the election result. Bolsonaro’s chief of staff said Tuesday that the administration had agreed to a transfer of power, but some of the president’s supporters have continued to demonstrate against the election results.

In his calls with foreign leaders such as U.S. President Joe Biden, Lula has emphasized climate cooperation. He pledged in his victory speech to reach zero deforestation and, according to Reuters, has been in talks with authorities in Indonesia and the Democratic Republic of the Congo about creating a global alliance for forest protection since before his victory. Norway and Germany have already signaled they plan to unblock environmental aid that they froze over Bolsonaro’s poor climate record. The president of Lula’s Workers’ Party also said Lula will attend next week’s U.N. climate conference in Egypt; Bolsonaro, who presided over soaring deforestation in the Amazon, had not announced plans to attend by Thursday.

In an interview in the September/October issue of Nueva Sociedad, Amorim waded into today’s thornier foreign-policy topics, offering clues as to how Lula may navigate them in office. He expressed a nonaligned position on U.S.-China tensions. On trade—with both China and the European Union—Amorim said Latin American countries should push for guarantees that help local industry. He also emphasized the threat of nuclear weapons use in Russia’s war in Ukraine; in a separate interview, Amorim supported negotiations to end the conflict and said BRICS members could back them.

Latin American countries should especially work to strengthen their ties with Europe, Amorim said, calling the continent “very important in the multipolar game.” As a starting point, it now appears far more likely that a long-stalled trade agreement between the EU and Mercosur—paused in part over concerns about Bolsonaro’s environmental record—will be approved.

Amorim has stressed that Latin American integration is crucial to Lula’s foreign-policy doctrine. True to form, Lula’s first in-person meeting with a head of state as president-elect was with Argentine President Alberto Fernández on Monday. “I want to give him the hug he deserves,” Fernández said, calling Lula a “leader in the region.”

When I was the science officer at the American Embasy in Brasilia, Celso Amorim was the foreign ministry's adviser to the science ministry. The US wanted to hold a joint science meeting of senior scientists. Celso Amorim was not helpful; he was was not a big fan of the US. However, the meeting did happen. There was some agreement, but nothing much was prodiced as a reult. Fortunately, the science minister was a lot friendler towards the US than Celso Amorim was.

EU Warns That Fed Rate Rises Could Lead to World Recession

 The Financial Times reported that the EU warned that Fed rate increases could lead to world recession. It said:

The Federal Reserve is leading a worldwide rush of central bank rate rises that risks tipping the world into a recession, the EU’s top diplomat said, as he warned the union is not fighting its corner in the world.

Borrell’s words on US monetary policy follow the World Bank’s warning last month that rate rises by multiple central banks could trigger a global downturn in 2023, as it argued the “degree of synchronicity” by central banks was unlike anything seen in five decades.

His warnings come as the World Bank and IMF kick off a week of joint meetings in Washington, where officials will discuss the multiple threats to the global economy. The fund is expected to downgrade its global economic forecasts for the fourth consecutive quarter.

Are Central Banks Going Bankrupt?

 The Financial Times-looked at whether central banks like the Federal Reserve can go bankrupt. The answer was no, but there are effects. It quotes from a paper by Seth Carpenter at Morgan Stanley:

Central bank profits and losses matter . . . but only when they matter. Before the 1900s, the subject of economics was called “political economy.” Central bank losses that affect fiscal outcomes may have political ramifications, but the banks’ ability to conduct policy is not impaired . . . . . . 

Starting with the Fed, all the income generated on the System Open Market Account portfolio, less interest expense, realized losses, and operating costs is remitted to the US Treasury. Before the Global Financial Crisis, these remittances averaged $20-25 billion per year; they ballooned to more than $100 billion as the balance sheet grew. These remittances reduce the deficit and borrowing needs. Net income depends on the (mostly fixed) average coupon on assets, the share of liabilities that are interest free (physical paper currency), and the level of reserves and reverse repo balances, whose costs float with the policy rate. From essentially zero in 2007, interest-bearing liabilities have mushroomed to almost two-thirds of the balance sheet.

As the chart below shows, the US central bank’s net income (which have been passed back to the US Treasury) has turned negative, and Morgan Stanley forecasts the losses will rise as interest rates rise.

Money Is Still Free

Real interest rates are still negative, they are way below the rate of inflation.  The last Consumer Price Index (CPI) inflation reading in August was about 8.3%. The current Fed funds rate is about 2.5%.  The current two- year Treasury bond rate is about 4.1%.  The ten-year rate is about 3.75%.  None of the interest rates is nearly as high as the inflation rate.  Many people think the inflation rate is dropping, but even if it has dropped to around 6%, it is still about 2% higher than interest rates.  So, money is still on sale.    

Interest rates have been about zero, and mortgages have been about 3%, but house prices were not going up fast until the pandemic, when they skyrocketed.  If house prices, or other asset prices, increased at a normal rate, the asset price would only go up by about the same amount as the interest rate, about 3%. Of course, the stock market was booming through much of this time, except for the beginning of the Covid pandemic.  In any case, the interest rate, almost zero for big borrowers or a few percent for normal people, was well below the rate of asset appreciation.  That continues today, despite the Fed’s rate increases. 

Now, instead of zero interest, we have 3% or 4% interest, but asset appreciation at 8% or 9% is well above that rate.  Real interest rates are still below zero, although nominal interest rates have gone up.  The economy is out of whack.  Real interest rates should be above zero. 

The Fed should keep increasing interest rates until they are higher than the rate of inflation.  They say they intend to, but Wall Street now thinks the Fed should stop periodically to check the inflation rate, so that interest rates do not get ahead of inflation.  If inflation rates do not slow down, this means that the Fed will continue to maintain a negative real interest rate, which is an enormous gift to investors. 

After the “great recession” of 2008, the Fed embarked on a plan of keeping rates low by buying up trillions of dollars’ worth of bonds, thus keeping interest rates low.  In essence it destroyed the bond market, because the Fed was always buying bonds.  In a normal economy, if there are not customers buying bonds, the interest rate goes up to encourage people to buy bonds.  If a company needs to raise money, they have to offer bonds with a rate that will make people buy them.  But if the Fed will buy anything and everything, there is no reason to offer higher interest.  This has been called quantitative easing, or QE. 

As part of the Fed’s new fight against inflation, it has introduced quantitative tightening, in which it will wind down or sell off its enormous bond holdings.  This will operate in tandem with its raising interest rates the old-fashioned way.  Since QE is relatively new, being used in earnest only after the 2008 recession, QT if even newer.  Janet Yellen tried it in 2017, when it appeared to contribute to a significant stock market fall and was discontinued.  So, we do not have a lot of data on what it likely to happen when the Fed tries it this year. 

The Fed held about $9 trillion of Treasury bonds and mortgage-backed securities on June 1.  It planned to reduce its holdings by $47.5 billion per month for three months, and then to increase reductions to $95 billion per month.  It remains to be seen how interest rate increases and QT work together. 

The one recent example we have was in the UK, where the new government’s economic plan of reducing some taxes led to a run on bonds (“gilts” in Britain), which forced the Bank of England (the British Fed) to step in and buy bonds as it and the Fed had done under QE, in essence a reversal of QT.  QE has been used to increase liquidity, to grease the bond market, in times of economic difficulty.  Could QT create the reverse condition and create market difficulties by removing liquidity?  We may find out by trial and error.  QT might end up being a greater threat to market stability than interest rate increases.