Vulnerability, Exchange Rate and International Reserves of Gold, Oil and Fore,

Imagine a Latin American country sitting on US$350 billion of international reserves, while running current account deficit, fiscal deficit and paying an interest bill on public debt that hovers above 5% of GDP every year. Given the enormous opportunity costs of hoarding such chest of gold, how could that money ever be used outside a crisis situation, without unleashing the very currency appreciation that it disguisedly tried to curtail? Brazil could well be in that position by the end of 2010 if the same rate of reserve accumulation observed in 2007 prevails in the next 18 months (and, in fact, the current pace is not too far from it).

Since 2002, strong capital inflows have sustained a process of exchange rate appreciation in Brazil, briefly interrupted in the last quarter of 2008 by the financial crisis. To be fair, several other emerging market currencies behaved likewise. For most of this period the sum of the current account and direct investment has posted positive figures, accumulating US$ 90 billion since 2003. Net portfolio inflows amounted to US$ 80 billion in total from 1Q03 through 3Q08 (having spiked to US$ 48 billion in 2007) and net loan flows totaled a positive US$75 billion in the same period (excluding IMF flows). In this environment of abundant liquidity, Brazil prepaid the IMF in November 2005. Since then, the CB and the Treasury interventions in the market have escalated amassing net purchases of US$ 169 billion by September 2008, with international reserves (IR) piling up to above US$ 200 billion.