The Dreamy Union
BRAZIL-ARGENTINA
Argentina and Brazil are mulling the creation of a common currency for the two nations, an ambitious plan that has been met with skepticism from economists, CNBC reported Tuesday.
The proposal was unveiled during a meeting in Argentina this week between Brazilian President Luiz Inácio Lula da Silva and his Argentinian counterpart Alberto Fernández.
Lula said the common currency would be designed for trade and transactions between the neighbors, which are also Latin America’s largest economies. He added that the currency could later be adapted by other members of Mercosur, South America’s major trading bloc.
The two leaders explained that the goal is to reduce the dependence on the US dollar and other foreign currencies, which they describe as harmful, the Associated Press noted.
Still, details of the plan remain unclear, as the currency does not yet have a name or deadline. Brazil’s Finance Minister Fernando Haddad noted that the two nations were not looking for a euro-style monetary union.
Analysts quickly shot down the proposal as “pie in the sky,” noting that there were major distinctions between the two economies while highlighting the rapid shift of political winds in the region.
Argentina has been experiencing economic issues with an inflation rate last year of 95 percent and a depreciating currency. Nearly four in 10 Argentinians live in poverty.
Brazil has been faring better but saw its inflation rate in 2022 exceeding the ceiling set by the central bank for a second straight year. The country’s development prospects are still bleak, and it hasn’t had a primary budget surplus since 2013.
Observers added that the initiative appears to be more about politics, as Fernández will seek reelection this year amid ongoing economic woes.
Brazil and Argentina Are Talking About a Common Currency. It Won’t Work.
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Inflation is running at less than 6% in Brazil but at nearly 100% in Argentina. The two country’s presidents have said they’re considering creating a common currency.
Anita Pouchard Serra/BloombergAbout the author: Barry Eichengreen is professor of economics and political science at the University of California, Berkeley.
Luiz Inacio Lula da Silva and Alberto Fernández, the leaders of Brazil and Argentina, are talking to one another. That’s the good news. The bad news is that they’re talking about a common currency.
Brazil and Argentina are natural trading partners because of their geographical proximity and complementary resource endowments. Unfortunately, their political and commercial relations were less than warm during Jair Bolsonaro’s presidency in Brazil, which ended last month. Bridging this gulf could help to mend the two countries’ economic rift and allow them to recapture exports lost to China. Growing their bilateral trade could provide a much-needed boost to their stagnant economies.
But talking about a common currency is not the right way of going about this. Say “common currency” and most people immediately start thinking about the euro. Clearly, the idea of a South American euro is ludicrous. Monetary and financial conditions in the two countries could not be more different. Inflation is running at less than 6% in Brazil but at nearly 100% in Argentina.
The hope, presumably, is that Argentine inflation would fall to Brazilian levels, not the opposite. But we know from Argentina’s history that efforts to tame inflation by tying the government’s monetary hands inevitably end in grief. The last time that Argentina tried this, with the Convertibility Plan in 1991, the currency collapsed within a decade. The economy collapsed along with it.
The other necessary conditions for a smoothly functioning common currency are also missing in the Southern Cone. Economically, there is no harmonization or integration of the two countries’ fiscal systems. Labor mobility between Argentina and Brazil is close to nonexistent. Politically, the situation is, if anything, even more dicey. Will votes on the Monetary Policy Committee of their imaginary central bank be split evenly between the two countries, as Argentina presumably prefers, or will they be proportional to population, as Brazil undoubtedly will insist?
It is not surprising that the two presidents’ joint letter, published on Sunday, was met with astonishment, if not derision. This led other officials, such as Brazilian Finance Minister Fernando Haddad, to clarify his government’s intentions. The goal is not to phase out Brazil’s real and Argentina’s peso in favor of a common currency, he and other officials explained, or to create a new central bank. Rather, it is to create a common “unit of account” in which bilateral trade can be invoiced. It is to allow trade between the two countries to be financed and settled in their respective national currencies rather than the U.S. dollar.
These ideas remain to be fleshed out. That common unit of account would presumably just be an average, maybe a weighted average, of Brazilian and Argentine currencies. Credit for trade invoiced in reals or pesos would be provided by banks, whose loans would be guaranteed by their respective governments.
These ideas at least are not wacky. The fact that Brazilian companies importing from Argentina have to first buy dollars with reals and then sell those dollars for pesos in order to pay their peso import bills saddles them with additional costs. Better would be a direct market on which pesos and reals could be traded for one another. It would be simpler. It would allow one transaction to be substituted for two.
Similarly, that importers have to obtain trade credit from U.S. bank—since most trade credit is in dollars—is a further source of costs. It is also a source of vulnerability, since dollar credit can dry up abruptly if the Federal Reserve raises interest rates faster than expected, or something goes wrong in U.S. financial markets, or the Congress, heaven forbid, fails to raise the debt ceiling.
But talking about a “common South American currency” and additional government guarantees for banks providing local-currency financing is the wrong way to go about this. Brazil and Argentina don’t need a common unit of account; they need a foreign-exchange market on which their currencies can be traded for one another. They don’t need government guarantees for banks providing trade credit. They need well-capitalized banks with reason to expect they’ll be paid back what they lend.
A more stable exchange rate between the two currencies would also foster bilateral trade. Here the onus is on Argentina, which needs to bring down its triple-digit inflation. Research has shown that when two countries have credible, inflation-targeting central banks, their bilateral exchange rate will be relatively stable. This relative stable exchange rate would provide much of the trade-promoting benefit of a common currency.
In addition, Argentina needs to loosen the capital controls imposed by its government to preserve scarce foreign reserves. Exporters from other countries complain that those controls prevent their Argentina customers from obtaining the foreign currency needed to pay their bills. Of course, it would be suicidal for Argentina to lift its controls before correcting the monetary and fiscal imbalances that are at the root of its runaway inflation.
In other words, the first order of business is “own house in order.” Discussions of common currencies, common units of account, and common policies should proceed later—much later.
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