Among the First to Recover

Did you miss my urgent strategy update last week?

If so, before reading any further, be sure to watch it now. Or, if you prefer, review the transcript.

In a nutshell: The calm before the next financial storm could be prolonged for a few more quarters.

Moreover, during this period, while the U.S. and Western Europe remain bogged down in debt and rising unemployment, select countries that have largely escaped the crisis will forge ahead.

Two outstanding examples: Brazil and China. I will cover the former today and leave the latter for the next time.

Why Brazil Was Among the LAST
To Suffer From the Financial Crisis
And Is Among the FIRST to Recover Now

Central Brazil, circa 1952. Top: Martin Weiss, age 6, under single-engine plane. Middle: Irving Weiss pushes stalled Willys. Bottom: Martin Weiss (left) with brother and father (right) wait for barge river crossing.

I know Brazil intimately because that’s where I was brought up, where my wife Elisabeth was born, and where my brother Joe lives today.

In the late 1940s and early 1950s, Dad searched throughout Latin America for a place to buy a second home and invest some money.

He tried Cuba, Costa Rica, and Colombia. But it wasn’t until we thoroughly explored Brazil that Dad found what he wanted.

We journeyed through Brazil’s interior using “sturdy” single-engine planes … in our 4-wheel drive Willys … and on not-too-shaky river barges. Our entire family fell in love with Brazil, and we made it our second home.

That was more than a half century ago. And yet, amazingly, the reasons Dad chose Brazil back then are precisely the same reasons Brazil is among the first choices of international investors today: political stability, vast resources, and a bright future.

But unfortunately, Dad never invested much in Brazil, because until the day he died, that future never came. Brazil ran massive budget and trade deficits, relying heavily on foreign capital to survive. It became one of the world’s largest debtor nations. And when foreign debts came due, even larger debts were piled on.

Reckless fiscal and monetary policies were the norm. On-again, off-again hyperinflation corroded the economy, corrupted politics, and eroded the fabric of society.

I experienced the consequences first-hand, and the town where I went to high school was a case in point.

Piracicaba, Brazil; November 8, 1964: The Comurba, the largest construction project in the interior of the state of SÃ£o Paulo, which collapsed the day before as a direct consequence of inflationary factors.

Corrupt city officials pocketed the meager tax revenues. So when city workers tried to collect their paychecks, there was no money left and they got city IOUs instead.

Worse, the inflation was so rapid, by the time they cashed in their IOUs a few months later, they’d already lost nearly half their purchasing power.

One day, while I was in biology class, we heard an ominous thundering sound coming from the center of town: The Comurba, a 15-story, 237,000-square-foot construction project, had collapsed. And a day later, when I took these photos, they had still not dug out all the victims.

Fortunately, the Plaza — a popular movie theatre in the complex that had already been opened — was not in session. Otherwise, I might have been among them.

What caused this tragedy? It appears cement costs had surged so rapidly, the builders began mixing in too much sand. Worse, to compensate for surging construction costs, they also decided to add a couple of extra stories not contemplated in the original blueprints. In sum, the on-the-ground, concrete consequence of price inflation was a great pile of rubble.

Let this serve as a warning to politicians in Washington who still think they can paper over their fiscal sins without long-term consequences … who don’t realize that their bailouts are actually making this crisis far worse.

Let this also serve as a stark reminder to investors — to largely steer clear of countries where politicians continue to pursue deficits, debt, and self-delusion … and to focus mostly on those where the leaders have learned from past mistakes.

Ironically, that includes Brazil today. Nearly every penny of foreign debts has been paid off. Inflation is under control. Large foreign exchange surpluses are piling up.

Result: Instead of being one of the world’s largest debtor countries, Brazil is now one of the world’s largest creditor countries. It’s even among the biggest holders of U.S. Treasury securities.

Other key facts:

While the U.S. Federal Reserve has cut official interest rates to practically zero, Brazil’s central bank has kept its key rates high, helping to enforce monetary discipline and prevent speculative bubbles. Thus …

While the U.S. was experiencing a massive housing boom, Brazil’s mortgage financing was limited to less than 1 percent of GDP.
Unlike their counterparts in Europe, Brazil’s banks largely avoided U.S. mortgage securities.
Before the global financial crisis, Brazil’s central bank was widely criticized for over-regulating its domestic banks. Now, it has been widely applauded for keeping them out of trouble.
Most important, Brazil’s central bank now has the leeway to cut interest rates to help the country recover more swiftly.

Thanks to this tight regime, the economy has already bounced back to approximately where it was before the financial crisis in September, as evidenced by the stock market, direct foreign investment, credit creation, and auto sales.

And overall, Brazil’s economy seems to have escaped the crisis with a relatively quick and mild recession. It …

Grew at about double the pace of the U.S. economy in the first nine months of 2008 …
Fell by half the pace of the U.S. in the fourth quarter of 2008 …
Contracted by one-eighth the pace of the U.S. in the first quarter of 2009 (-0.8 percent vs. -6.4 percent), and …
Is likely to grow twice as fast as the U.S. in 2010 (even assuming economists are right about a U.S. recovery).

China has replaced the U.S. as Brazil's largest trading partner!

Another major factor: For the first time in history, China has now surpassed the United States as Brazil’s largest trading partner.

At the same time, the country has successfully diversified its trade, expanding its exports to Latin America, Africa, and other countries in Asia.

Right now, Brazil’s stock market is a bit overpriced and may be overdue for a correction. But once the market dips, select Brazilian utilities and bluechips, as well as the leading ETF tied to Brazil’s stock market (EWZ), may be screaming buys.

Good luck and God bless!

Martin

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