What is a government to do when rampant inflation cripples a currency and the public’s faith in it’s ability to hold value?
Brazilian policymakers faced this very question nearly thirty years ago. In a bold move, they chose to answer this question by creating and marketing a new currency–the Unit of Real Value–which existed in name only. No coins or bills of the Unit of Real Value would be issued. This is the story of Brazilian hyperinflation, and at its epicenter is a story about changing a culture using basic psychology principles.
After the energy crisis of the 70s, Brazil experienced a decade and a half long battle with hyper-inflation.
Prices rose so rapidly that stores were forced to change sticker prices multiple times a day. As the prices of goods like milk and eggs skyrocketed, the ten dollars you had today was only worth a fraction of that come next week.
As Brazilians experienced price increases day after day, they began to expect further price increases–a self fulfilling prophecy which shattered public confidence and furthered the economy’s downward spiral.
Brazil found itself in constant flux, with new administrations taking their own shots at hyperinflation. They tried freezing prices, slashing zeros, and they even changed their currency five times in one decade. Nothing seemed to solve Brazil’s hyper-inflationary woes.
The program which would ultimately pull Brazil out of the gutter was the Real Plan.
It was drafted by a group of Brazilian economists and it sought to do two main things:
1. Slow down the creation of money
2. Restore the people’s faith in Brazilian currency.
The importance of the first task–slowing down the creation of money–cannot be ignored, and much of the plan’s success is owed to the monetary and exchange rate policies that targeted the root causes of the crisis. That being said, we’re going to focus on the second task–restoring the public’s faith.
Once 1993 hit, the Brazilian Cruzeiro was no longer a viable way to store value—whatever cash you had lost value by the hour. As a result, Brazil experienced a bizarre culture which favored the here and now over the future–any planning for the future was foolish as time sucked the value out of your money.
Officials needed to break this inflationary mindset of Brazilians and convince them that Brazilian currency was stable.
To do this, they created a ‘virtual’ currency called a Unit of Real Value—a URV. It was virtual in the sense that it did not exist in bills or coins. The sole purpose of this currency was to act as a unit of account. You would go to the store and prices would be listed in URVs, but you would still pay in Cruzeiro. URVs remained stable in the midst of hyperinflation. This provided Brazilians with a stable anchoring point for purchasing goods. URVs didn’t fluctuate much, but Cruzeiros were still devaluing rapidly.
You would go to the store and buy Milk for 1 URV. 1 URV might equal 10 Cruzeiros. When you went back to the store next week, Milk would still be 1 URV. But now, 1 URV might equal 20 Cruzeiros.
Nobody really understood what a URV was, but it was simple to use, and over time it became easier to just think in terms of URV and then do the Cruzeiro conversion at the counter.
The purpose of the URV was to provide people with a stable anchor point and gradually get them to expect those prices to remain constant. After only a few months of the URV system, officials felt that the public no longer feared future price increases and they introduced the Brazilian Real. The Real would replace the Cruzeiro and its value would be equal to one URV. All wages and prices in Brazil would now be listed and paid in Real.
The Brazilian government had essentially created a new currency and marketed it in a way that communicated stability and credibility to the Brazilian people.
They did so using an anchoring mechanism to reprogram the minds of Brazilians, getting them to believe that currency could hold its value.
More importantly, a people regained control over their lives. In a BBC article, Clemens Nunes explains, “Brazilians suddenly became capable of making plans for the future, instead of having to live in the here and now”
When you read about the URV maneuver, many people describe it as if the Brazilian government ‘tricked’ their people into thinking their money would hold its value. On some level this is true; however, the real plan was characterized by transparency. There were no surprises or shocks–officials simply took a bet on their understanding of their people’s psychology…and it worked.