Saturday, July 9, 2011

Inflation: How Fake Money Saved Brazil

Since I'm on the South American inflation beat, here's a story I meant to post last fall.
From NPR:
This is a story about how an economist and his buddies tricked the people of Brazil into saving the country from rampant inflation. They had a crazy, unlikely plan, and it worked.

Twenty years ago, Brazil's inflation rate hit 80 percent per month. At that rate,  if eggs cost $1 one day, they'll cost $2 a month later. If it keeps up for a year, they'll cost $1,000.

In practice, this meant stores had to change their prices every day. The guy in the grocery store would walk the aisles putting new price stickers on the food. Shoppers would run ahead of him, so they could buy their food at the previous day’s price.
The problem went back to the 1950s, when the government printed money to build a new capital in Brasilia.

 By the 1980s, the inflation pattern was in place.
It went something like this:

1. New President comes in with a new plan.
2. President freezes prices and/or bank accounts.
3. President fails.
4. President gets voted out or impeached.
5. Repeat.

The plans succeeded at only one thing: Convincing every Brazilian the government was helpless to control inflation.

There was one more option that no one knew about.  It was dreamed up by four guys at the Catholic University in Rio. The only reason they enter the picture now  —  or ever — is because in 1992,  there happened to be a new finance minister who knew nothing about economics.  So the minister called Edmar Bacha, the economist who is the hero of our story.

"He said, 'Well, I've just been named the finance minister. You know I don’t know economics, so please come to meet me in Brasilia tomorrow,' " Bacha recalls. "I was terrified."
Bacha had been waiting for decades for this call.

He and three friends had been studying Brazilian inflation since they were graduate students — four guys at the campus bar complaining to each other about how no one else knew how to fix this.  And now they were being told "Fine, do it your way."

Bacha was invited to meet the president.

"I asked for an autograph for my kids," Bacha says. So the president wrote Bacha's kids a note that said, "Please tell your father to work fast for the benefit of the country."

The four friends set about explaining their idea.  You have to slow down the creation of money, they explained. But, just as important, you have to stabilize people's faith in money itself.  People have to be tricked into thinking money will hold its value.

The four economists wanted to create a new currency that was stable, dependable and trustworthy.  The only catch: This currency would not be real.  No coins, no bills.  It was fake....MORE