Brazil’s economy has often been a textbook forex course subject for forex traders regarding inflation’s effect on a currency since the Brazilians used an especially unique and creative way of dealing with the problem that had seriously undermining the value of its currency for years.
Until 1986, Brazil had approached inflation by fairly conventional economic means, with yearly inflation then topping 100 percent, after inflation for 1985 had been 225%. The Brazilian government then decided to take a series of more drastic measures to deal with the increasingly dire hyper-inflationary spiral that its country was suffering from.
Nevertheless, by March of 1990, a series of failed plans left inflation in Brazil at an almost unbelievable 5,000% compared with March of 1989.
The Real Plan
By 1993, Brazil had basically failed at all of its official attempts to control inflation. Furthermore, the Brazilian public had lost confidence in the credibility of its government to make any significant headway against the problem.
Paper money had lost most of its perceived value in Brazil, and people were no longer supportive of any plan that included wage or price freezes. Government spending would have to be reigned in, and a new approach to controlling inflation needed to be implemented.
As a result, the new Minister of Finance, Fernando Henrique Cardoso, appealed to some of his academic friends to come up with an economic plan to beat the vicious inflationary cycle Brazil was suffering from. The result of this appeal is what became known as the Real Plan.
The Real Plan had three main elements:
- The creation of a Social Emergency Fund through a constitutional amendment.
- A monetary reform in which a new unit of account would be adopted which would later become the national currency.
- A new foreign exchange policy and an aggressive approach to international trade.
The Social Emergency Fund was approved and extended, thereby allowing the Brazilian government to collect certain tax money to be used in programs of “great economic and social interest”, in addition to expanding the government’s privatization of state owned businesses.
The URV Monetary Reform
Since wage and price freezes had been almost completely useless in reigning in inflation, the innovative Real Plan instead created an index of prices. This was called the URV, which stands for Unidade Real de Valor or Real Unit of Value.
All prices, wages and services were priced simultaneously in Cruzeiro Reals and in URVs. While the price for any given item might fluctuate in Cruzeiro Reals, the price would remain constant in URVs. The URVs were also pegged to the value of the U.S. Dollar and fluctuated accordingly.
The primary advantage of this plan was that the Brazilian mentality of indexation — that involved including inflation adjusted numbers when doing business — was eventually eliminated. Furthermore, as people developed confidence in the URV, this plan helped restore the credibility and stability of the Brazilian currency.
Eventually, as part of the Plano Real introduced under President Itamar Franco, the Brazilian Real was introduced to replace the Cruzerio Real in July, 1994, and it was defined to equal one URV.
This transition to a far more stable currency and inflationary environment also marked the beginning of Brazil’s explosive economic expansion which continues to this day. Furthermore, the Brazilian currency has recently shown such strength that formal intervention to soften it is now being considered by the Brazilian Central Bank.