Gustavo Franco

Two papers out of specific chapters of his doctoral dissertation were published in peer reviewed journals and had some relevant repercussion on his later work of fighting hyperinflation in Brazil:

"Fiscal Reforms and Stabilization: four hyperinflation cases examined" was published in The Economic Journal (vol. 100, no. 399, March 1990) disputed Thomas Sargent's popular explanation to the sudden end of hyperinflation as result of a wide-ranging fiscal "regime change". The role of dollarization and of currency reforms were wrongly downplayed by Sargent, as argued by Franco.

"The Rentenmark Miracle" published by Rivista di Storia Economica (Second Series, Volume 4, 1987), then republished in Barry Eichengreen (ed.) Monetary Regime Transformations London, Edward Elgar Publishing Ltd, 1991, was an account of the unique experience in Germany of Wertbestandiges Notgeld - that is, emergency monies of private issuance and with "stable value" as they had indexation clauses -, and the way this led to the rentenmark experience. As argued by Franco the rentenmark was a crucial step in the German stabilization, and not a "cosmetic measure", as put by Thomas Sargent.[3] In fact, the rentenmark model was very relevant for the design of the Brazilian 1994 monetary reform, known as "Real Plan", in which a similar quasi-currency, under the name o URV (acronym for Unidade Real de Valor) played a vital role for the ending of Brazilian hyperinflation.[4]

Much later, in 1995, Thomas Sargent wrote an article on the Brazilian URV, evoking the German experience with the rentenmark and arguing, as per the mathematician David Hilbert, that one could not solve the hyperinflation problem by "changing the name of the independent variable".[5] The URV, argued Sargent, would have been "a sideshow that hasn't touched the fundamental causes of inflation",[6] and again Franco took issue with that, writing in 2017, but this time on the back of the successful adoption of the URV mechanism. According to Franco: "Understandably", Brazilians "did not take these observations seriously" as "the country was enchanted by the URV mechanism in view of practical problems it solved elegantly, efficiently and voluntarily, so that they received with blunt indifference a thesis from an outside observer claiming that the mechanism had no utility".[7]

In sequence to the work on monetary reforms in the early years of the Republic, Franco published several pieces on the Brazilian monetary experience in the years prior to the Great Depression. All this work is in Portuguese except "Aspects of the Brazilian Experience with the Gold Standard", in Pablo Matín Aceña and Jaime Reis (orgs.) Monetary standards in the periphery: paper, silver and gold, 1854-1933 (London, Macmillan Press. 2000). Later, his research on the early years of the Republic would communicate well with his work of Machado de Assis newspapers articles as per his selection of chronicles under the title "O olhar obliquo do acionista" ( "Shareholders oblique look", as literal translation).

Franco worked in collaboration with Winston Fritsch in a series of projects supported by the OECD Development Center. One publication was Foreign direct investment and industrial restructuring: issues and trends (Development Centre Studies, OECD Development Centre, OECD, Paris, 1991), another was "Efficient Industrialization in a Technologically Dependent Economy: The Current Brazilian Debate" in Competition and Economic Development Committee of Competition Law and Policy, OECD, 1991.

In sequence, Franco and Fritsch worked in two projects directed by Gerry Helleiner for WIDER (World Institute for Development Economics Research) of the United Nations University during 1990 and 1991. The first was on the influence of trade orientation on development models and was published as "Foreign Direct investment and patterns of trade and industrialization in developing countries: notes with reference to the Brazilian experience" in G. K. Helleiner (org.) Trade Policy, Industrialization and Development: a reconsideration. (Oxford, Clarendon Press for UNU-Wider, 1992 ISBN 0-19-828359-8). The second, on the same issues but focused on trade and industrial policies was published as "Import repression, productivity slowdown, and manufactured export dynamism: Brazil,1975-1990" in Gerry Helleiner (org.) Trade policy and industrialization in turbulent times (London: Routledge for UNU-Wider, 1993, ISBN 0-415-10711-3).

Franco and Fritsch also worked in projects for UNCTAD[8] and ECLA,[9] and published in the academic circuit on these same issues.[10] Franco would return to these themes only after 1995 when, as deputy governor of the Central Bank responsible for international affairs organized a Census on foreign direct investment into Brazil that has been conducted and published each five years since 1995.

Franco served as Deputy Economic Policy Secretary at the Finance Ministry from May to October 1993 by invitation from the newly appointed Minister, Fernando Henrique Cardoso, the fourth Finance Minister of president Itamar Franco, who had become president in December 1992 after the resignation of Fernando Collor de Mello. The  other economists in the group were Winston Fristch, as Secretary of Economic Policy and Edmar Bacha as special adviser. In his memoir, Cardoso recollects that “with a small team facing a gigantic challenge, as a Brancaleone’s Army, ... we started to work, under a very discouraging political atmosphere”.[12] This team faced a paradoxical pressure: not to repeat economic shocks and to produce some solution to inflation, then approaching 30% per month. The team's first major announcement was described by Franco, as a “non-package” or rather “an ambitious collection of medium term fundamentalists agendas”,[13] curiously named as PAI (acronym for Plano de Ação Imediata, Plan of Immediate Action), released on June 13th, 1993. In sharp contrast with previous stabilization attempts, this document seemed to point that the Real Plan would start by the end offering “some sort of strategic planning of actions in issues associated with the so-called fiscal and monetary fundamentals to stabilization”.[14]

Franco was appointed Deputy Governor for International Affairs at the Central Bank on September 8th, 1993 when Pedro Malan was appointed Governor. Simultaneously, Pérsio Arida was designated president of BNDES, and André Lara Rezende replaced Malan was chief negotiator of then pending Brazilian external debt. With this enlarged composition, the economic team around minister Cardoso started preparations towards the Real Plan.

In parallel, Franco had executive responsibilities in International Affairs at the Central Bank related to operational aspects of external debt restructuring under the Brady Plan, then at decisive moments, the administrative structures in charge of exchange controls, bound to be transformed by an ambitious deregulation process, the FOREX trading desk and international reserves management.

At the moment Franco and Malan started working together at the Central Bank, the debt negotiation process was around the precise form of exchange of Brazilian currency denominated deposits owned by creditors (under the MYDFAs, Multi Year Deposit Facility Agreement) for newly issued bonds according to the Brady plan’s menu. In the final sequence of this process, Franco was in charge of the composition of the collateral guaranties for the new bonds under the Brady scheme. These guaranties would take the form of US Treasury Zero Coupon bonds with certain features, with a face value of approximately US$ 18 billion (and market value of US$ 2,8 billion) to be acquired with funds provided by the IMF under a stand-by agreement.

However, IMF representatives did not feel comfortable with the drafts of the Real Plan shown during the negotiations of the stand-by agreement and refused to go on with the loan, forcing the Brazilian authorities to develop some alternative strategy to acquire the US Treasury bonds in the secondary market using Brazil’s international reserves. The deal was described in detail in Guilherme Fiuza’s book in the chapter titled Sorry, Mr. Fagenbaum.[15]

Right next to completing Brazil’s Brady Plan version, simultaneously with the Real Plan, Franco dealt with Paris Club debt and the Dart family, who did not wish to adhere to the Brady exchange. With these issues sorted out the challenge for the Republic was to return to international markets with new bonds and proceed with the building of a yield curve. The new program coordinated and executed by Franco comprised 16 new issues in 10 different currencies, between 1995 and 1998, totaling US$ 8,2 billion, including the issuance of the so called "BR-27" (the first 30-year bond voluntarily issued in decades, falling due in 2027) in exchange for cash and for Brady bonds, thus recovering the previously offered collateral in US Treasury bonds.[16]

Exchange controls deregulation was one of the greatest challenges of the International Affairs section of the Brazilian Central Bank, a modernization imperative and an essential condition for the prevalence of supply and demand as determinants of the exchange rate.

The architecture of liberalization was based on the creation of new and segregated market for US Dollars in which rates were determined by supply and demand in parallel to the official market and to compete upfront with the “black market”. Initially fed only by Dollars sold by tourists, the scope of transactions was gradually extended, while, liberalization in the official market, along with a better balance of payments stance, resulted in gradually eliminating the spread between official and free markets.

From 1988 to 2006, when all legal markets were unified, deregulation consisted in expanding the nature of transactions that could take place in the free market, including gold related arbitrages, and remittances from non-resident local currency accounts,[17] though always preserving full identification of players.

After 1995, under Franco's direction, the Central Bank introduced several new rules for leads and lags in foreign trade, portfolio investment and turned “registry” of foreign capital inflows into a statistical event, and no longer dependent on authorization. Interestingly, however, one key innovation introduced along with liberalization of outflows was the selective restriction applied on certain types of inflows, mostly of a short-term nature. Capital surges had been producing restrictive measures in many countries, most visibly (for Brazilians) Chile, where restrictions took the form of a “quarantine”, or a minimum stay for foreign capital. In Brazil, instead, restrictions were implemented mostly as a tax of foreign exchange inflows, and without any “quarantine”. The formula was used many times over in later moments of foreign exchange abundance in order to reduce appreciation and/or the extend maturities of foreign liabilities.[18]

Before the Real Plan, five stabilization attempts failed between 1986 and 1991 all of which involving price freezes, all but one creating a new currency and one, the so-called Collor Plan in 1990, with an asset freeze much like monetary reforms in Europe following World War II.[24] These failed experiments were called "heterodox shocks" not only because of direct intervention in prices and intrusive currency reforms, but also for their practical disregard of fiscal "fundamentals" and monetary policies. The Real Plan followed a different path opening several reforms agendas attacking fundamental disequilibria at the core of the hyperinflation process.

The first was related to the institutional organization of the monetary system. the National Monetary Council was recaptured and reduced to three members (ministers of Finance and Planning and the Governor of the Central Bank), recomposing the commitment of top level decision making to price stability. Sometime later a Monetary Policy Committee (known as COPOM - acronym of Comitê de Política Monetária) was created securing Central Bank's independence in fixing the interest rate.

Next, federal banks, and especially Banco do Brasil, had to recognize previous losses, be recapitalized, abide by "Basle Rules" and cease to have unrestricted accommodation at the Central Bank. Provincial banks entered a severe adjustment program through which several liquidations and privatizations reduced their size to almost negligible. Some private banks in trouble entered a program through which the Central Bank financed liquidations, resolutions and changes in control of banking activities. It was a heavy agenda with the banking system, public and private, to reorder the monetary system and its governance.

There were numerous fiscal adjustment initiatives, starting with several rounds of debt refinancing with adjustment programs with the states during 1993-1998. The Federal Government gave accommodation to states in exchange for orthodox fiscal programs and several limitations as to their fiscal policies. These programs templates provided a framework to a new Public Finances Law, proposed in 1999, creating benchmarks and limitations for indebtedness and wages expenses, later approved under the designation "Fiscal Responsibility Law", held to be a major progress in securing fiscal balance in the public sector in Brazil .

Another important initiative was the 1993 Constitutional Amendment known as Social Emergency Fund (Fundo Social de Emergência, approved during the constitutional revision in March, 1993) which removed most of earmarking in the budget, and allowing the National Treasury to regain control of budgeted expenses. Even so, primary fiscal results were weak during the first few years after 1994. Due to the advancement of reforms, these weak fiscal numbers did not become an issue until the Asian crisis in 1997 and especially in 1998 with the Russian crisis, when Brazil entered an agreement with the IMF and started a decade long period of primary surpluses at the level of 3% of GDP.

Franco left the Central Bank after the IMF Agreement and after the reelection of Fernando Henrique Cardoso for a second term in 1998. Franco received late in 1998 Euromoney's prize “Central Banker of the year, 1998”.[25]

Shortly after, Brazil moved into what was known as the "tripoid" policy: floating exchange rates, primary fiscal surplus and inflation targets. Brazil was ready, at this point, to switch from the exchange rate "anchor" into the inflation targets regime. Franco's account of controversies around the use of the exchange rate in the stabilization effort and of the dialogue between short term policies and long term reform goals was laid out in several of his writings, some in English.[26]