U. S. Monetary Policy Stimulates the Economy, Unfortunately the Economy Stimulated is Brazil’s.

And Brazil is Not All That Happy About It

The U. S. monetary policy called Quantitative Easing 2 is a technical name for Federal Reserve action in which it buys a massive amount of government bonds from the banking system.  The theory behind this is that it lowers interest rates as the Fed pushes up bond prices, which stimulates the economy and it gives banks a lot reserves, which they in turn will use to support new loans to businesses, which stimulates the economy.

That this policy could not work in the U. S. is supported by economic theory at least 70 years old.  It is the “liquidity trap” where increased reserves are held as increased reserves, and not used to create new loans.  The liquidity trap is amply described and pictured here.

Well, it turns out the Fed policy of QE2 did stimulate and support the Brazilian economy. Investment is flowing to Brazil, as this report in the Financial Times describes.

Why is Brazil such an attractive destination for investors? Ask Japanese housewives. They are pumping $4bn a month into Brazil, mostly through mutual funds, placing further pressure on the real to appreciate.

The reason for their and other investors’ enthusiasm is partly Brazil’s economic success and partly distortions that have left Latin America’s largest economy with high real interest rates.

So what’s the problem?  Well the fact that U. S. rates are low means investors are taking their money from the U. S. and investing it is Brazil, driving up their exchange rate, and weakening the economy by making Brazil’s exports less competitive.   Furthermore, Brazil is experiencing inflation above target levels, so the central bank is increasing interest rates, which makes the country even more attractive for foreign capital which dirves the currency up even further.

Brazil’s success story is that

Few other large economies are growing as strongly as Brazil, whose gross domestic product rose 7.5 per cent last year and is on track to expand another 4 per cent this year. The growth has come amid peak prices for Brazil’s commodity exports, particularly iron ore, sugar and coffee, as well as rising home consumption.

See, you get investment by having a growing economy that supports and generates additional investment.  That this is missing from the U. S. economy is why this policy doesn't work for the U.S. economy.

On the plus side it is nice that someone is benefitting from U.S. economic policy, since it is certainly not the U. S.