Brazilian Economy in the First Republic

Black and white image of a coffee farm in Vassouras, Brazil, illustrated by Louis-Jullien Jacottet in 1861. A two-story building with several windows, people in period clothing, surrounded by trees, a hill, and a stream in front.
A coffee farm in the Brazilian city of Vassouras, depicted by Louis-Jullien Jacottet in 1861. Coffee was Brazil’s most important crop at the time. Public domain image.

The First Brazilian Republic, also known as the “Old Republic,” lasted from 1889, with the deposition of Emperor Dom Pedro II, until 1930, when a coup d’état brought Getúlio Vargas to power. During this period, Brazil remained a major coffee producer. However, there was also a decline in rubber production and the rise of numerous textile and food factories in the country. The economic policy of the period was heavily influenced by the coffee-growing sectors, but, at times, their interests were challenged by the government. Overall, the First Brazilian Republic was a time of great economic transformations, paving the way for even deeper changes that would occur in the Vargas Era (1930-1945).

Liquidity Challenges at the End of the Empire

In the final decades of the Second Reign, Brazil experienced a significant expansion of wage labor amid the abolition of slavery. While slaves had little need for money, wage earners depended on it for their subsistence. This led to an increased demand for money in agriculture — especially during harvest time, when agricultural workers were typically paid. However, the Brazilian economy did not have enough paper money to meet this demand, leading to liquidity problems in the country. Two factors exacerbated this scenario:

  • There were few banks, and they were concentrated in the city of Rio de Janeiro. Seasonally, money was redirected to the countryside.
  • People preferred to accumulate money rather than keeping it in bank deposits. Thus, when confronted with greater demand for paper money (from agriculture), banks had to reduce their cash reserves to meet it. This led to the “inelasticity of the circulating medium,” as credit did not expand appropriately.

To address low liquidity, an 1885 law authorized the National Treasury to issue money to lend to banks, up to a limit of 25 million contos, the Brazilian currency. However, this measure had only a temporary effect.

There were two perspectives on how to tackle the economic woes. For the “papelistas” (paper currency enthusiasts), more currency should be issued to meet all money demand. On the other hand, for the “metalistas” (gold currency enthusiasts), issuing currency would mean devaluing it, effectively confiscating citizens’ purchasing power. Thus, they advocated for Brazil to adhere to the gold standard, a system that would prevent any currency issuance unless there was sufficient gold to back it. In particular, they supported the exchange rate set in 1846, of 27 pence (British currency) per mil-réis (Brazilian currency).

In 1888, a Banking Law was enacted that attempted to reconcile these two monetarist perspectives. Although it was unsuccessful, Brazil managed to reach the 1846 parity during the Ouro Preto Cabinet, one of the administrations during the Imperial Period. This cabinet took advantage of economic prosperity to reestablish the gold standard and offer credits to agriculture, in an attempt to prevent the proclamation of the Republic. However, in 1889, military sectors allied with civilian sectors and overthrew Emperor Dom Pedro II.

The Encilhamento and its Consequences

When the Republic was proclaimed, Brazil was still experiencing a liquidity crisis. To try to solve it, the country’s first Finance Minister, Rui Barbosa, implemented the Encilhamento in 1890, through a series of decrees.

The Encilhamento was the relaxation of paper money issuance, which would be limited and guaranteed by public bonds. In practice, the government was authorized to put more money into circulation in the economy, as long as it was linked to the offer of credit for industrial projects. Moreover, banks were allowed to participate in the capital of companies. Although it was imagined that this measure could cause inflation, it was thought that this could be mitigated by the strong demand for money and by industrial growth.

This economic plan was inspired by the system of national banks in the United States, created in 1863 and 1864 by the National Bank Acts. These laws also allowed banks to issue currency backed by government public debt securities. To implement the same idea in Brazil, the country was divided into several banking regions, each with a distinct bank responsible for issuing currency. For example, in the central region, the responsible bank would be only the Banco dos Estados Unidos do Brasil (BEUB). After this initial regionalization was deemed insufficient, Banco do Brasil (BB) and Banco Nacional do Brasil (BNB) also gained issuance powers.

It’s true that the Encilhamento generated many viable firms and led to the beginning of a process of industrialization by import substitution. However, the expansion of the monetary base had rapid and violent effects, compounded by the adverse context of the time:

  • Higher-than-expected inflation: The industrial expansion expected by the government did not adequately occur, as many shell companies were created. Additionally, immigrants and former slaves did not have such a high demand for money, as their income was small or non-existent. There was an attempt to liquidate low-quality industrial projects by merging the Banco dos Estados Unidos do Brasil (BEUB) and the Banco Nacional do Brasil (BNB), forming the Banco da República dos Estados Unidos do Brasil (BREUB). However, this was unsuccessful, as Rui Barbosa’s successors at the Finance Ministry, Alencar Araripe and the Baron of Lucena, did not maintain the policy of banking restructuring.
  • Devaluation of the exchange rate: As more Brazilian paper money was in circulation, its individual value decreased. Thus, the exchange rate moved from 27 pence per mil-réis to 12 pence per mil-réis. Other factors affecting the Brazilian exchange rate were the collapse of the British house Baring Brothers, operating in Argentina, causing capital flight in Latin America; political instability in Brazil; a drop in coffee prices; and the growth of Brazil’s external debt (necessary to maintain the level of imports in the face of falling coffee prices).

Due to these issues, the Encilhamento became known as a plan doomed to failure. Indeed, its very name is pejorative, referring to the moment of preparing horses for a race, as if the Brazilian economy was being prepared for a period of unbridled speculation, much like betting on horse races. The term “Encilhamento”, in this negative sense, was coined by monarchists who wanted to discredit the Republic.

During the presidency of Prudente de Moraes (1894-1898), there was an attempt to reconcile the papelista and the metalista perspectives. He negotiated and got a loan of 7.5 million British pounds from the Rothschild bankers in England. In return, Brazil was to implement austerity measures, such as increasing taxes — which was done in the Banking Law of 1895. However, this loan also did not resolve Brazil’s liquidity crisis.

The First Funding Loan and the Golden Era

Brazil’s problems would end from 1898 onwards, when the Campos Sales government (1898-1902) reached an agreement with the Rothschilds and the London and River Plate Bank. Brazil argued that it was unable to pay its external debt, and managed to secure the first Funding Loan — a loan of up to 10 million British pounds, through the issuance of public bonds, with an interest rate of 5% per year. From 1898, for 3 years, Brazil would not be obligated to pay either the principal of the renegotiated debts or the interest on them. For the subsequent 10 years, the country would only pay the interest, while the payment of the principal remained suspended. Afterwards, after these 13 years, the debts and interests would have to be paid over 50 years. Additionally, there was the issuance of the so-called rescission bonds: public bonds that would be offered to owners of Brazilian railways, as a guarantee of profits for this unprofitable sector.

To grant this loan, creditors made tough demands on Brazil, which had to adjust public accounts and withdraw paper money from circulation. In addition, the government was prohibited from taking new loans until 1901. The loan’s guarantee were the revenues from the Customhouse of Rio de Janeiro.

Due to these countermeasures, the first Funding Loan faced resistance in the Brazilian parliament, especially from coffee growers, who depended on government support. Despite this, the agreement was approved with the consent of politicians from São Paulo and Minas Gerais, who controlled politics at the time, and was executed in an orthodox fashion by Finance Minister Joaquim Murtinho. He believed that unfit companies should be eliminated from the market and did not hesitate to implement measures of strong monetary contraction, tax increases, and cuts in public spending. As a result, there was an appreciation of the exchange rate and a wave of bank crashes — causing immediate deleterious effects and contributing to the growing unpopularity of President Campos Sales.

On the other hand, the first Funding Loan contributed to the emergence of a new phase in the economy of the First Republic: the “golden era”, as stated by Brazilian economist Winston Fritsch. Indeed, the presidency of Rodrigues Alves (1902-1906) was much more peaceful, because direct foreign investment was entering the country, and because Brazil became very relevant in the global rubber market. The abundance of money allowed, for example, the resumption of public works (such as road construction), the re-equipment of industry, and GDP growth. However, there were still some economic problems in Brazil:

  • Appreciation of the exchange rate: The exchange rate appreciated to the extent that it became impossible to maintain it at the rate of 12 pence per mil-réis. To address this, the government created the Conversion Box (Caixa de Conversão) in 1906 — a mechanism for issuing notes convertible into gold (and vice versa), at a fixed exchange rate. In practice, this meant that Brazil would adhere to the gold standard to contain currency appreciation. According to Brazilian economist Celso Furtado, this measure had the consequence of “socializing losses”: the devalued exchange rate benefited coffee growers, who would earn more paper money by exporting coffee abroad, at the expense of the entire population, who would suffer from expensive imports and inflation.
  • Drop in coffee prices: Due to a superharvest in the state of São Paulo, the international price of coffee plummeted. Faced with this, Rodrigues Alves chose not to involve the federal government in backing the price of coffee, believing it unfair to favor coffee growers for a problem they created themselves (excess production). This view was shared by the Rothschild bankers and the states of the Northeast Region of Brazil, which were not linked to the coffee economy.

As the federal government would not assist the coffee growers, the states of Minas Gerais, Rio de Janeiro, and São Paulo collaborated to do so: in 1906, they created the Taubaté Agreement, to appreciate the prices of this product. Under the terms of the pact, these states would take out foreign loans to buy coffee surpluses, store the stocks in commercial warehouses, and charge an extra tax on the export of the product. Through such measures, they hoped to reduce the coffee supply, thus increasing its price, benefiting the coffee growers. However, as argued by Celso Furtado, the Taubaté Agreement had a major flaw: even if it managed to prevent the expansion of Brazil’s coffee supply, the price appreciation it promoted would encourage other countries to enter the international coffee market.

In 1907, São Paulo began the coffee appreciation scheme, supported by a foreign loan. Thanks to the Taubaté Agreement and the gold standard, the governments of Afonso Pena (1906-1909) and Nilo Peçanha (1909-1910) were characterized by economic prosperity. Brazil’s exports and imports increased, as did the supply of money and the country’s international reserves. Additionally, Brazilian industries could import machinery more easily. The only problem in this scenario was inflationary pressures, due to the greater influx of foreign currency into the economy.

The Impact of WWI and the Second Funding Loan

From 1910 to 1914, President Hermes da Fonseca governed Brazil without the support of the coffee elite, and began facing several issues:

  • Resumption of payment of the principal of the external debt, as per the terms of the first Funding Loan. As large amounts of foreign currency started leaving the country, there was also a reduction in domestic currency, in line with the gold standard.
  • Decline of the rubber cycle: In Asia, plantations established by the English and the Dutch began producing better and cheaper rubber. Consequently, Brazil lost its prominence in the international rubber market.
  • Drop in coffee prices: Due to an antitrust lawsuit in the United States, part of the Brazilian coffee stock had to be sold.

Brazil was undermined by the normal functioning of the gold standard, which led to an outflow of foreign currency, but it believed it could easily obtain external financing to compensate for this. In reality, from 1912 onwards, it became difficult to raise new loans from creditors, for they were concerned about the growth of government spending and political deterioration in Europe, especially in the Balkans. Negotiations between the Brazilian government and its creditors were suspended on June 27, 1914.

On July 28, 1914, World War I (WWI) broke out, and Brazil responded promptly. The Conversion Box was closed, meaning the adoption of a floating exchange rate, trending towards devaluation due to the scarcity of pounds amid the war scenario. In addition, Brazil declared a moratorium on its external debt and began issuing inconvertible notes.

In September 1914, Brazil resumed negotiations with creditors, aiming for a second Funding Loan. The same year, this agreement was concluded between the Brazilian government and the English (Rothschild), the French, and the Germans. Brazil would borrow 15 million pounds. As in the first Funding Loan, interest payment would be suspended for 3 years, and principal debt payment suspended for 13 years, with installments spread over 50 years. However, this time, the revenue from all Brazilian customhouses — not just that of Rio de Janeiro — was offered as collateral.

Initially, Brazil was not heavily affected by WWI. However, during the government of Venceslau Brás (1914-1918), the problems exacerbated. On the one hand, Brazilian imports were hindered by difficulties in bringing machinery from Europe. On the other hand, Brazilian exports were hampered by the torpedoing of merchant ships by Germany, a reduction in coffee and rubber prices, and the confiscation of Brazilian coffee stocks in Germany by the Allies. In this adverse scenario, Brazil adopted a contractionary fiscal policy and an expansionary monetary policy — for example, through the expansion of credit offered by Banco do Brasil, especially in the rural interior during harvest times.

Despite these difficulties, according to Celso Furtado, there was an “industrial surge” in Brazil during WWI. It was a strong — albeit momentary, fragile, and unsustainable — industrial expansion in the country, caused by several factors:

  • Obstacles to the importation of European products in the midst of the war: The foreign products that reached Brazil were few and expensive.
  • Presence of idle industrial capacity in Brazil: Thanks to the “golden era” of the First Republic, Brazil was able to import a large amount of industrial machinery. When the war broke out, this compensated, to some extent, for the woes in the international industrial machinery market.
  • Devalued exchange rate: Due to a shortage of pounds sterling, domestic products were relatively cheaper than imported ones, what stimulated national industry.
  • Investments in industry: With the decline of coffee, many coffee growers began to invest in industrial ventures.

Amidst the war, from 1917 until 1919, the government of Venceslau Brás implemented a second plan to back the price of coffee. Unlike the Taubaté Agreement, this second plan did not involve external loans — it was financed entirely by currency issuance. This intervention was less effective than the previous one, but, in 1918, the concerns related to coffee ended fortunately. Due to a severe frost in the plantations, the international price of coffee nearly doubled (temporarily) that year.

From Growth to Recession in the Post-WWI Period

In 1919, President Epitácio Pessoa began governing in a post-war economic growth scenario, despite the appreciation of the Brazilian currency. At that time, coffee prices were high, external demand for Brazilian products was recovering, and there were still obstacles to importing European products. Taking advantage of this context, the government inaugurated a large public works program — some works were even related to the celebrations for the centenary of Brazil’s independence in 1922.

However, at the turn of 1920 to 1921, the economic scenario changed. Faced with post-war inflation, Europe and the United States adopted contractionary policies. Thus, the price of coffee plummeted, and a recession emerged in Brazil. For President Epitácio Pessoa, the main concerns at this time were to contain the devaluation of the currency (which could negatively impact the budget, external debt, and inflation) and to address the crisis in the coffee sector.

In 1920, measures were taken to provide liquidity to the entire economy, not just to coffee growers. There was a small issuance of National Treasury notes, and the Banco do Brasil‘s Rediscount Portfolio (Carteira de Redesconto) was created. It could issue Treasury notes and use them to pay for private titles owned by banks, injecting money into the economy.

Later, in 1921, the government concluded that direct intervention in the coffee market was necessary, so that the policy of containing currency devaluation would not create unbearable pressures for coffee growers. In this regard, Brazil decided to carry out the third plan to back the price of coffee. Initially, the government only endorsed the purchase of coffee sacks by a private broker and financed this operation through the Rediscount Portfolio. Over time, the Treasury’s indebtedness to Banco do Brasil made it difficult for the bank to maintain the coffee policy. Thus, at the end of 1921 and in 1922, the government contracted British loans to support coffee prices. Not only were these loans effective in carrying out the third intervention in the coffee market, but they also contributed to improving the Brazilian balance of payments.

In 1922, however, the fiscal situation remained critical, as there was a gigantic short-term debt of the Treasury to Banco do Brasil. For the bank to continue financing the government, Congress authorized its Rediscount Portfolio to rediscount public bonds. In practical terms, this caused a strong expansion of the monetary base, fueling inflation in the country.

By the end of 1922, the government of Artur Bernardes (1922-1926) began in a climate of economic recovery. This occurred because the price of coffee was increasing (due to successful government intervention), imports were decreasing (due to currency devaluation), and the global deflationary scenario had little impact on Brazil (since the monetary base had been expanded).

However, the foundations supporting the Brazilian economy at the time were quite fragile, as the balance of payments was vulnerable to problems in the coffee market, and there was a chronic fiscal crisis. To solve these issues, Artur Bernardes proposed two major measures:

  • Changes in the backing of coffee prices: The government would no longer buy and store coffee surpluses. Instead, all coffee would be compulsorily retained in regulatory warehouses by the government. Furthermore, the government would no longer finance the appreciation scheme. Instead, coffee growers would fund the operation, and to cover production costs, they would have to take out loans guaranteed by the ‘deposit certificate’ of the coffee. Finally, the entity responsible for managing the coffee sector would be the newly-created Permanent Coffee Backing Institute (Instituto de Defesa Permanente do Café). These measures aimed to increase revenue, appreciate the exchange rate, and strengthen the balance of payments.
  • Fiscal adjustment: There was a drastic reduction in the public deficit, largely enabled by cutting short-term public investments and creating the Income Tax in 1922.

The problem was that both measures were undermined by the effect of the monetary policy, which became increasingly expansionist. To support the coffee price, it was crucial to have an institution that would act even when national commercial banks did not want to or could not. However, foreign banks were not willing to play this role. Facing this, the government implemented a monetary reform, closing the Rediscount Portfolio and transferring the power to issue paper money from the Treasury to Banco do Brasil. In practice, the bank could finance the coffee policy in a very similar way to how it had done through the Rediscount Portfolio. However, this currency issuance led to an inflationary and foreign-exchange crisis.

To tackle this crisis, the initial approach was to seek a new loan from the British, in exchange for executing economic reforms. In this regard, in early 1924, Brazil received a mission of experts led by Edwin Samuel Montagu, who suggested reforms such as selling 50% of Banco do Brasil to foreigners — which the government accepted, but the Rothschilds did not. However, by mid-1924, the British government imposed restrictions on granting external loans, as it aimed to strengthen the pound sterling. Because Brazil would not have external support, the country had to adopt highly contractionary measures. Additionally, the responsibility for financing the coffee sector shifted from the federal government to the state of São Paulo in 1924, with the creation of the Instituto Paulista de Defesa Permanente do Café (IPDPC) (Paulista Institute for Permanently Backing Coffee). Two years later, the name of this entity was changed to Instituto do Café do Estado de São Paulo (São Paulo State Coffee Institute).

The recessionary adjustment led by Artur Bernardes managed to contain inflation and improve the exchange rate, but it came at a high economic and political cost. The economy regressed, unemployment increased, and the exchange rate appreciated by over 40%. Moreover, as the president was from the state of Minas Gerais, his administration contributed to deteriorating relations between the political elites of São Paulo and Minas Gerais.

From Growth to the Effects of the 1929 Crisis

In 1926, Washington Luís assumed the presidency of Brazil with the main economic proposal of returning to the gold standard, in a context where recessionary adjustment was no longer necessary. Thus, his Finance Minister Getúlio Vargas was able to radically change monetary and foreign-exchange policies.

For coffee growers, it was interesting to contain currency appreciation, so that their earnings from coffee exports were maintained. With this objective, the Stabilization Box (Caixa de Estabilização) was created, following the model of the old Conversion Box: it would issue notes that were convertible to gold deposits made in it. The conversion between paper money and gold would occur at the devalued rate of 6 pence per mil-réis, representing a significant change from previous rates. The intention was that, when there was enough gold, Brazil would adopt a new currency (the cruzeiro) and the entire monetary base would be convertible to gold.

In 1927 and 1928, the Brazilian economy was in good condition. Washington Luís maintained moderation in public spending, and the balance of payments was stabilized by the gold standard. As foreign investment flowed abundantly into the country, Brazil’s GDP grew and there was burgeoning demand.

However, the economy was based on fragile pillars, as it depended on favorable external conditions. If the global demand for Brazilian coffee reduced, fewer resources would enter Brazil and, due to the gold standard, domestic liquidity would decrease. Additionally, if a contraction in global demand was accompanied by a reduction in external credit, Brazil would also struggle to obtain foreign loans to finance coffee price support. In other words, in a scenario of capital outflow from Brazil, the country would be severely impacted by the functioning logic of the gold standard.

Recognizing this vulnerability, the Brazilian government opted for a contractionary policy in 1928, attempting to reduce the risk of problems caused by the gold standard in the future. Soon after, the situation worsened due to a coffee superharvest, causing coffee prices to fall. In 1929, Brazil was heavily affected by the Great Depression, which led to a massive capital flight and made true the fears concerning the Brazilian economy. Immediately, there was a drop in exports, government revenue, consumption, investments, and Brazilian international reserves. The solution to these problems, however, would be in the hands of Getúlio Vargas, who overthrew Washington Luís in a coup d’état and took power in the Revolution of 1930.


For many authors, the Brazilian economy during the First Republic was characterized by ups and downs. At that time, Brazil was a poor and unequal country experimenting with how to best integrate into the international liberal economy. Hence, periods of economic growth or contraction, fixed or floating exchange rates, fiscal crisis or fiscal moderation were observed. The Brazilian Republic inherited the coffee dependence from the Imperial Period, but introduced industries in the country and paved the way for a consistent industrial policy that would emerge in the Vargas Era (1930-1945). Overall, the economy in the First Republic should be remembered as something unstable, incipient, but necessary for Brazil’s evolution.




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