Brazil Has 5 Massive and Nasty Weapons Against QE2 To Contain U.S. Dollar Devaluation

Brazil is furious at the Fed's QE2 and its continuous money printing. It was revealed today that Brazil is keeping 5 weapons to contain the devaluation of the U.S. dollar. Some of the weapons will indeed have  nasty effects on investors.

1. Increase of U.S. Dollar purchases, either by the CB or by Brazil's SWF

2. Offer Reverse Exchange Swaps

3. Resumption of charging income tax on the earnings of foreign investors

4. Increase of the IOF tax for investors buying bonds.

5. Tax investments in the stock markets ad shares of Brazilian companies

Buying US dollars is likely to have short term effects only, much like the Bank of Japan did. In the long term, the Brazilian CB cannot beat the markets. However, the government could change the limitations which would give it unlimited firepower to buy US dollars by offering bonds in exchange.

Incomes taxes, or taxing the stock market is a huge concern for investors and will cause an immediate mini crash of the market.

The government prefers to keep the possibility of using this "arsenal" until evaluating results of next week's meeting of leaders of the G-20, in Seoul, South Korea.

The change of the Brazilian government is also relevant in this scenario. Measures to combat the overvaluation of the real, taken between November and December, will impact on the administration of President-Elect Rousseff.

The use of Brazil's Sovereign Fund to buy dollars is one of the measures stored on the shelf of the Ministry of Finance. To increase the firepower of the Fund, the government will have to edit a provisional measure (MP) allowing the Treasury to issue bonds for the portfolio of the FSB. Thus, the volume of foreign currency purchases by the Fund would be virtually unlimited, since all depend on the availability of the Treasury to issue new shares.

But in reality this may only happen if the government feels the need to give a show of force. Last week, Arno Augustin, the Treasury secretary,  made it clear that the government did not have time to use this mechanism. "We are keeping this instrument because it is a war of medium and long term that does not end tomorrow."

Another measure that has not left the drawer is the Banco Central in the future market of dollars. For this, the Fed could resume the supply of so-called reverse exchange swap contracts, an instrument that functions as a kind of future dollar purchases. This type of contract has not been offered by CB since May 5, 2009.

The government is also studying a mechanism that may limit speculation in the currency. Much of the operations performed by financial institutions in the futures market, which indicate a bet that the Real will appreciate, has a counterparty in exporters and foreign investors. The idea would be to close the space for operations that do not have that kind of counterparty, or uncovered positions, or "short positions."