Investment Grade Is a Medal; the Cycle Is Still the Judge

When a country receives foreign applause, it should count the silverware after dinner.

Brazil received today what Brasília will treat as a diploma of maturity: Standard & Poor's raised Brazil's sovereign rating to investment grade. The market will celebrate. The government will smile. Newspapers will use words like "historic," "confidence," "new level," "recognition," and "serious Brazil." The Bovespa may react like a teenager accepted into a rich man's club. Many will say we have finally entered the room of adults.

Perhaps. But one should remember: an adult is not someone invited to dinner. An adult is someone who knows how to behave after the wine is gone.

Investment grade matters. It is not irrelevant decoration. It reduces barriers for certain investors, improves risk perception, lowers the cost of capital in some circumstances, and signals that the country has traveled far from the currency, fiscal, and inflationary despair of previous decades. Denying this would be petty. Brazil in 2008 is not Brazil in 1989, nor 1999, nor 2002. There are international reserves. There is a better-regulated banking system. Inflation has been domesticated, though not killed. There is domestic demand. There is formalization. There are profitable banks. There is a popular president. There are expensive commodities. There is China. There is credit. There is self-esteem.

The danger lives exactly there.

Countries rarely break when they know they are fragile. They break when they start believing their fragility has been retired.

Brazil is being congratulated for crossing a bridge. The problem is that many will conclude they have reached the destination. They have not. A rating is a photograph, not character. A thermometer, not an immune system. A paid opinion on repayment capacity, not a moral ordering of the republic. The agency looks at indicators, compares risk, measures trajectory, and assigns a seal. But it does not measure the vanity born from the seal. It does not measure the willingness to spend more because someone outside said we are trustworthy. It does not measure the arrogance of a political elite that confuses validation with absolution.

Brazil specializes in turning external signals into internal self-deception.

We have been blessed by global liquidity, appetite for emerging markets, and Chinese hunger for raw materials. The world wants iron ore, soy, oil, meat, sugar, ethanol, pulp, energy. Brazil discovers it was born sitting on goods other people desire. This is good. But natural resources have a bad moral quality: they allow societies to postpone difficult conversations.

A productive nation must improve because its wealth depends on discipline. A nation exporting abundance can become rich enough to remain incompetent for longer.

Brazilian politics will turn this news into a narrative. It will say the world recognized the correctness of the national project. Lulism will say Brazil became large because it included the poor, strengthened the internal market, preserved macroeconomic responsibility, and distributed income. The opposition will say investment grade is the inheritance of prior stabilization, the Real Plan, fiscal responsibility, and reforms the PT itself fought. Both will hold part of the truth. And, as always, both will use the part of the truth that serves their own altar.

The real country, outside the partisan mass, should ask a different question: what kind of growth are we building?

Domestic demand is growing. Credit is growing. Household consumption is growing. Investment is growing. Government is growing. Tax revenue is growing. Confidence is growing. The problem is that almost everything is growing while prudence is shrinking. The Brazilian believes he has entered an era without reversal. The businessman believes demand will continue. The bank believes the consumer will continue paying. The politician believes revenue will continue rising. The foreign investor believes "emerging market" is a category and not a succession of national accidents. The civil servant believes the state can promise more. The middle class believes financing means ownership. The elite believes the country has finally been forgiven by its own history.

History does not forgive. It merely grants deadlines.

There is an almost religious detail in modern politics: every government wants to convert favorable conditions into its own virtue. If the wind helps, the ruler declares himself a genius navigator. If the tide rises, he declares himself engineer of the ocean. If commodities rise, he calls it a national project. If credit expands, he calls it inclusion. If the stock market rallies, he calls it confidence. If the rating improves, he calls it redemption.

The true test will come when the wind turns.

And it will turn. Not because I wish it. Because cycles exist. The financial world outside has been showing signs of disease since last year. The names are foreign, and therefore seem distant: subprime, Bear Stearns, CDO, funding, liquidity, structured credit. But disease does not respect language. The global financial system has built a web in which the default of an American borrower can alter the risk appetite of a European fund, which can affect flows into emerging markets, which can affect the Brazilian real, which can affect inflation, rates, corporate debt, the stock market, investment, and employment. Whoever thinks this is exaggerated still lives in the century of the steamship.

Brazil is better prepared than before. That does not mean it is armored. Armor is a word journalists use when they still do not understand the ammunition.

The government will be tempted to use this rating as a license. License to spend, intervene, subsidize, choose champions, accelerate public banks, manipulate incentives, expand directed credit, and reinforce the thesis that Brasília, when excited, produces prosperity. The people will be tempted to believe future income can already be consumed in the present. The businessman will be tempted to confuse financed demand with permanent wealth. The market will be tempted to confuse sovereign rating with protection against corporate stupidity.

The best response to investment grade would be institutional humility. Use cheaper capital to raise productivity, simplify taxes, improve infrastructure, reform education, increase savings, reduce privileges, professionalize the state, improve regulatory frameworks, lower the cost of entrepreneurship, open the economy intelligently, and turn good times into permanent capacity.

The likely response will be another: celebration.

Cicero would understand the risk. The republic is lost when public men convert the common good into factional property. Aquinas would ask whether the new wealth is ordered toward a just end or merely toward the multiplication of appetites. Augustine would remind us that the earthly city loves its own glory even to the contempt of truth. Marcus Aurelius would counsel sobriety in triumph, because external praise does not alter the inner nature of man.

Brazil needs Marcus Aurelius. It will get a rating carnival.

The forecast of this letter is simple. This April 30, 2008 will be remembered as the symbolic peak of a certain self-confidence. Perhaps more good news will still come. Perhaps other agencies will follow the same direction. Perhaps foreign capital will continue entering. Perhaps the stock market will rise. Perhaps Brazil will look, for a few years, like a country finally destined for greatness. But the seal received today will also create intoxication. The country will begin treating itself as a solved case. And countries that treat themselves as solved cases stop solving their cases.

When the global crisis deepens, and it still can deepen, Brazil will discover it is not outside the world. It may suffer less than others. It may cross better than in the past. It may even emerge politically strengthened in the short term. But the idea of armor will be disproved. The exchange rate will move. Credit will tighten. Exports will feel it. Companies leveraged in dollars will remember that foreign currency is not a toy. Public banks will be summoned as firefighters. The state will leave the crisis larger than it entered. And every emergency intervention, when it works a little, becomes a permanent addiction.

This is the part that worries me: Brazil may cross the crisis with manageable damage and learn the wrong lesson. The correct lesson would be: we had reserves, regulation, and luck; we must reduce fragilities. The political lesson will be: the state saved us, therefore the state should command more. The difference between those two readings may define the next decade.

Brazil does not need to choose between naive markets and a messianic state. It needs to choose between prudence and vanity. The market without morals becomes a casino. The state without limits becomes the owner of society. Good politics exists to prevent both from lying too much.

Today we were handed a medal. May it not become imaginary armor.

Because the cycle, unlike the agencies, does not publish a report before downgrading a nation. It simply collects.

Investment grade is the portrait of a moment. The moral insolvency of a republic begins when it confuses the portrait with the soul.

Leo Bentier