ArpexCapital

Two days ago, Brazil decided to levy a two percent tax on all foreign investment in Brazilian stocks and fixed-income securities .

Some thoughts:

– Although the move was ostensibly targeted at speculators in the Brazil stock market, in reality it is meant to brake foreign investment and thus slow down the appreciation of the currency (the Real). The Real has appreciated 43% against the dollar since December, which has made the country’s exports much more expensive. The tax is about protecting the country’s exporters.

– Theoretically, the tax could plug some budget gaps for the government, although they deny that raising revenue had anything to do with the tax.

– Optically, the move looks bad. It reminds people of the old Brazil, where the government implemented quirky policies with unintended consequences. One article entitled Brazil Gets a Little Nutty , explains that odd moves like this one shows why one should avoid overweighting investments in Brazil, despite the country’s strong fundamentals.

– In reality, the move means very little and will change very little. If foreign investors slow down in Brazil, it will not be because of a 2% tax but because this move gives them pause regarding the predictability of the Brazilian government: you would be surprised how many people look at me funny when I talk about Brazil as a great investment thesis — they still lump Brazil in with South American neighbors like Argentina, Ecuador and even Venezuela. A move like this stirs up that image.

– As far as I know, this has no impact on investments in private companies in Brazil. If one invests in a private equity or venture capital fund in Brazil, one typically invests in a FIP (similar to a Limited Partnership). These are TAX FREE to foreign investors.

I am trying to confirm that PE/VC is not affected but it makes sense that it is not, since by definition it represents long-term investment in the Brazilian economy, not speculative/momentum investing.

– I have sympathy for the Brazilian authorities when I look at the unhealthy, ridiculous rise of the US market this year, which has been driven almost purely by institutional money and traders. In my humble opinion, there are few fundamentals behind the US market rally, except that companies have fired so many people and cut so many costs that reported earnings, as measured quarter over quarter, will soon “look” better. Instead of sitting and watching a similarly heated and potentially unhealthy rally in the Bovespa, the Brazilian government decided to act.

– In sum, the 2% tax is an interesting milestone on Brazil’s climb upward, not much more.

Onward…

So, we know Brazil continues to “run the table” with trade surpluses, strengthening currency and economic growth in the midst of worldwide recession. We know about its increasing international prestige – the 2014 World Cup, 2016 Olympics and, yesterday, election as a non-permanent member of the UN Security Council for the 10th time, a frequency matched only by Japan. We know about its burgeoning middle class, abundant natural resources and booming stock market.

What about the United States? My tag line for the last six months has been that “the short-term problems of the US are underestimated and the long-term problems are over-estimated”.

In the short-term, I don’t buy the hopeful reports of “green shoots” appearing in the economy and of unemployment having hit bottom. Over 500,000 people filed for unemployment benefits last week (yes, it was “less than forecast” – so what?) and we are on pace for national unemployment to rise above 10%. The real unemployment rate – people that want a job and have looked for one in the recent past – is 17%. The official unemployment rate for 16-24 year-olds is 21%.

Given that consumer spending makes up over 70% of our Gross Domestic Product (GDP), how will the economy recover if consumers have no jobs? Debt is also no longer readily available for the American consumer and, regardless, many have changed their wild spending habits, perhaps permanently.

Nevertheless, I feel it’s important to see everything through a historical context. The demise of the US has been predicted many times. For example, after the trauma of Vietnam, Watergate and the economic malaise of the 1970s, many foresaw the ascendance of the Soviet Union and the retreat of the US. Instead, communism collapsed and the US experienced 20 years of economic growth.

Why has the US always bounced back? Because freedom is the ultimate competitive advantage – the free market and individual liberty gives the US the agility to rebound. If you allow people to profit from their passions, to keep the fruits of their labor, they will naturally innovate and grow the economy. If you disconnect work from profit and confiscate the fruits of labor, you will suppress innovation and growth.

At the moment, my fear is that we are dampening our economic agility by swinging the pendulum too far away from the free market. It is understandable: the Great Recession that started in December 2007, like the Great Depression in 1930s, has made Americans wary of free markets and desirous of more regulation.

We already have unprecedented intervention/regulation in the industrial and financial sectors and, soon, we may have it in the health sector, in the form of universal health insurance.

This is an apolitical blog and I am not opining on whether there should be universal health insurance provided by the government. I am opining that it should not be implemented now: loading on the cost of a massive new entitlement will either necessitate higher taxes, which will smother growth, or more debt, which will result in higher interest rates, which will smother growth. Our deficit is already larger than any other country’s budget!

The only way we can climb out of this hole is through economic growth, which starts the virtuous cycle of higher employment and higher tax receipts for government (which allows us to pay off our debt and/or reduce the deficit). That is why our priority now should be pro-growth policies (e.g., lower corporate taxes), not further entitlement programs.

Regardless, the problems in the US will take several years to work out. We will not see real economic growth for another year and, even after that, growth will be tepid (below 3%) for another two more years. If we load on more debt, we will have a weak economy into the indefinite future.

So, for the moment, I am revising my tagline: the short-term problems in the US are underestimated… and so are the long-term problems.

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