This article was published by The McAlvany Intelligence Advisor on Monday, September 28, 2015:
Like flies attracted to honey, Brazilian politicians saw their opportunities and took them. Initially a money laundering investigation in Brazil focused on just one company, a manufacturer of electronic components that was being used by a criminal ring to hide and whitewash its illegal gains. The owner, Hermes Magnus, apparently discovered the activity back in 2008 and notified local police.
By March 2014 the investigation had spread to more than 230 individuals, including four criminal rings, with connections to the highest levels of both former Brazilian president Luiz Inácio Lula da Silva and his protégé, the current president, Dilma Rousseff, who replaced him in January 2011. It also reached into the executive suite at Petrobras, Brazil’s huge oil company owned by the government. Fifty-seven have already been arrested, and 46 of them have been indicted.
The press started calling the scam “Operation Car Wash” when it was learned that a currency exchange and money transfer service at the Tower Gas Station in Brasilia was involved.
The scheme got legs after Petrobras announced in September 2010 that it had discovered two potentially massive deposits of oil: the Tupi in the Santos Basin, and the Juniper, just off the coast of Rio de Janeiro. Although unproven, the company issued and sold $70 billion of new shares in order to develop the fields, and expanded the debit side of its balance sheet by $25 billion. That brought the company’s debt load to $170 billion, making it the most heavily indebted company in the world at the time, and drove its stock from $4 a share to $77. The temptation to dip into this massive pool was too much for politicians and company executives to resist, and deals were made. In exchange for cash, contracts were let to cronies. The amounts involved were fabulous, including more than $40 million paid to the Speaker of the Lower House. Even the Workers Party was involved, with the arrest of Joao Neto, the party’s treasurer, for receiving what the Wall Street Journal euphemistically referred to as “irregular donations.” The former Chief of Staff for President Lula, Jose Dirceu (shown above) was arrested for orchestrating a large part of the scandal.
Rousseff, however, denied any knowledge of the matter, despite the fact that during this period of time she was the chair of Petrobras. Furthermore, she insulted the intelligence of the Brazilian people when, during her run for reelection last fall, she promised “to supercharge the [Brazilian] economy while avoiding the corruption and mismanagement that have plagued other oil-rich countries in the developing world.” This outrageous denial almost cost her the reelection, and sparked massive rallies protesting the corruption that characterized her administration.
The scandal was so huge that Petrobras was forced to delay releasing its financial reports for 2014 until April 2015. In those reports, the company took a charge of $17 billion for overstating the values of Tupi and Juniper, along with the graft. In addition the company announced that it was suspending its dividend for all of 2015, and it was selling off some $13 billion in assets to raise cash.
The impact of this massive fraud continues to reverberate throughout Brazil, as well as across the planet. By itself, Petrobras is (or was) responsible for almost 10 percent of the country’s capital expenditures. With this scandal the weak economy that has already cost 500,000 Brazilians their jobs will cost another two million jobs over the next year and a half.
The Brazilian currency, the real, has lost 35 percent of its value compared to the dollar just since the first of the year. Unemployment has jumped from 4.9 percent to 7.5 percent, and is expected to exceed 10 percent next year.
As Brazil’s central bank tries to stimulate the moribund economy, it is causing inflation approaching 10 percent, and is causing credit agencies like Standard and Poor’s to downgrade the country’s debt to junk. This will impact American bond funds when either Fitch or Moody’s does likewise, forcing their managers to unload their Brazilian junk into an already overpriced junk bond market.
With interest rates approaching 15 percent, the average Brazilian is going to see his cost of living increase at the same time that the purchasing power of his earnings are declining.
The ripple effect of “Operation Car Wash” has yet to be fully played out, but it is reducing what used to be the world’s fourth largest economy to one much smaller, while putting egg on the face of Jim O’Neill, the Goldman Sachs manager who coined the term BRIC in 2001, to include emerging countries Brazil, Russia, India and China. He went so far as to claim that the BRIC nations would overtake the developed nations as soon as 2025.
What O’Neill didn’t take into account was that, given the opportunity, politicians and their cronies in companies like Petrobras simply could not resist helping themselves. By throttling the newly emerging economies with rules, mandates, and regulations while cutting themselves special side deals like “Operation Car Wash,” it didn’t take long for reality to set in.
All of which is a great disappointment to Edmar Bacha, the free market economist who was one of the “fathers” of the Real Plan developed in the early 1990s that ignited Brazil’s growth spurt:
I am disillusioned and upset with what’s happening. All the work that we did to create the real, to create stability, was destroyed [by the government].
It wasn’t just Lula and Rousseff who destroyed the Brazilian economy. The month before Rousseff took office in January, 2011, the legislative branch of the government voted itself an increase in politicians’ salaries: to $210,000 a year in a country where the per capita income is barely $16,000. And it has successfully resisted any attempts since then to reign in government spending.
The Economist: Brazil: Recession’s sharp bite
Wall Street Journal: Brazil Braces for More Pain
Mish Shedlock: Tracking the Implosion of Brazil; Be Careful of What You Wish; Perfect Storm; Email from Brazil; More Intervention Madness
Bio of Luiz Inácio Lula da Silva
Washington Post: Brazilian president’s handpicked successor leads, faces runoff
Background on Operation Car Wash
The New American: Interest-rate Increase Could Trigger Global Recession