In February of 2011, I wrote a piece about what I thought was a credit bubble in Brazil. I thought that the problem was serious and that it could potentially lead to a collapse. Most other commentators felt that there wasn't really a problem. For example I quoted a former central banker, Arminio Fraga, who said that there wasn't an issue. He said "We may have traces of subprime in the system…I don't think it has gone that far." He was wrong.
Since the crash, emerging markets have helped to spur global growth. The faith in their ability to continue growing seems eternal. Just today, July 12th, I saw a new report from Ernst & Young that suggests emerging markets will save the slowing world economy and provide a new engine of growth. It is all rather sad, because they won't. An excellent example is Brazil.
Brazil was fortunate in that it really did not see many of the problems that hurt most of the world during the recession. When most countries were contracting in 2008 to 2009, it grew 5%. Its growth continued to climb to 7.5%. But the party is ending. This year it is expected to grow only 2%. In fact it will be lucky to achieve even that. To see the reason why, we must look at why Brazil was able to do so well.
Brazil's growth has been based on its vast wealth in commodities. One of Brazil's principal exports is iron ore, which almost tripled between 2007 and 2011. The projected demand was so great that Vale, the Brazilian mining giant, has begun to build a fleet of massive ships to carry the ore. These ships, called appropriately Valemax, are about 400,000 tons among the largest ships ever built. Brazil is also particularly rich in agricultural commodities of all sorts. Thanks to demand and global warming, the prices for these commodities have been between 50% to 100% higher than they were in the previous decade.
Although weather did play a part, the prices for Brazil's commodities would not have been as spectacular had it not been for the demand from China. China's often double digit growth has pulled in raw materials of every variety, sending prices to new heights. Normally the anemic growth of the developed world would have limited the demand, but China and other emerging markets set the pace. This year China replaced the United States as Brazil's main trading partner a change now common throughout the emerging markets.
Like all the emerging markets, the economy in Brazil is dominated by the state. US style capitalism is considered too radical and unfair. The former president, Luiz Inácio Lula, was once a labor leader and relied heavily on state led consumption. Under his administration the state bank loan growth grew by 50% in 2009 alone, five times more than the private banks. He also encouraged consumers and the new middle class to go on a borrowing binge, which they did. The result was that consumer credit doubled in five years. This led to a real estate bubble and a debt service burden for consumers of 24%, much higher than the pre crash peak of 14% in the US.
But despite the predictions of economists like Earnst and Young and Jim O'Neill of Goldman Sachs, no economy grows forever. The three main pillars of Brazil's growth, commodities, China and credit are beginning to collapse.
I have been writing for some time about the problems in China. Most economists have predicted a soft landing, which I objected to last November. Despite the optimism, the 'landing' has been getting harder every day. The fall in China's economic growth has accelerating since it reached its peak in 2010. In the most recent quarter it fell from 8.1% to 7.6%. Some experts believe it could be even worse.
The slowdown in China has affected all sorts of commodity prices. Imports of commodities into China grew only 6.3% in June, half the forecast rate. The only reason it may have grown at all was to provide collateral for an enormous credit bubble. The slowdown in commodities will impact heavily on many countries rich in commodities like Chile, Australia and perhaps most of all, Brazil.
The end of the commodity boom will only worsen the collapse of the credit bubble. Loans overdue by 90 days hit 6%: the highest since records were started in 2000 and higher than the previous peak in 2009. The default rate is particularly troubling in a time of low unemployment. It also limits the scope for stimulus as banks refuse to lend.
Recessions can begin in a number of ways. Brazil is now confronted by slowdowns in its major export markets together with a home grown credit mess. It is doubtful that it can save itself much less the rest of the world.