By Sonja Rijnen-
Brazil and Argentina made headlines last month after appearing to get the ball rolling on the creation of a common currency that could have, in the long term, led to the world’s second-largest currency union after the Eurozone. Despite initial excitement, Mexico’s president Andres Manuel Lopez Obrador already said that his country would not join such a currency union and it now appears that actually, the focus is more on a common unit of account to be used for bilateral trade between the two largest economies in the region. However, although the project for a regional common currency may not come to fruition, there are various opportunities it would bring if it did.
The most obvious opportunity would be the facilitation of trade (also one of the key arguments for the introduction of the Euro in the late 90s and early 2000s). In general, trade currently makes up a relatively small portion of the region’s economies. Argentina and Brazil are relatively closed with trade representing approximately 33% and 39% of GDP respectively, the global average being 57%. This lack of trading activity has meant that the region is less globalized and many point to this as being a reason why Latin American countries often lag behind other emerging economies.
Importantly, Latin America does not only not trade much with the rest of the world but it also has low levels of intra-regional trade. Unlike Europe, Latam has never succeeded in reaching high levels of regional integration, although not for a lack of trying (see this article for reasons why). The introduction of a common currency would mean that Latin American countries would be encouraged to trade more among themselves because exchange rate volatility would be eliminated from the equation and the exchange of goods and services would be much cheaper.
Experts on international trade point to the importance of trading with your neighbours in order to establish successful supply chains that make a country more competitive on the global market. So, in theory, if Latin American countries increased regional trade, the volume of goods and services they would exchange with the rest of the world would also increase, bringing with it development opportunities.
A second opportunity a common currency would bring to the region is a decline in its economic reliance on the US and especially the US dollar. The region has already started turning away from the US and increasing ties with other partners, most notably China. Many Latin American leaders, including recently elected Lula in Brazil, gave campaign promises of decreased reliance on the US. As the US dollar is the world’s most widely used reserve currency, Latin American countries rely on their ability to secure dollars to make international transactions. If there was a common currency which was well regarded on international currency markets and could be used for trade, securing US dollars would be less important for many Latin American countries who currently find it difficult.
A final, less obvious, opportunity a Latin American common currency would bring may be the fact that integrating monetary policy and having one regional central bank could help with monetary stability. In 2022, the IMF released a study of 17 Latin American countries showing that “high levels of central bank independence are associated with reductions in the likelihood of high inflation episodes, especially when accompanied by reductions in central bank financing to the central government.” Central banks are best able to do their job of conducting “monetary policy to achieve price stability (low and stable inflation) and to help manage economic fluctuations” when they are independent from governments. However, this has not always been the case in Latin America, Argentina and Venezuela being key examples. There is now a fear that political change and governments at the extremes of the political spectrum may endanger monetary stability by using the tools of central banks to print money to finance spending projects.
By nature, if a common currency is introduced and there is one common central bank, this institution is much less likely to be beholden to the political whims of individual political parties within individual countries. Rather, the whole bloc would have to be taken into account when monetary policy is set. For a region like Latin America, where leaders have been known to use not only fiscal but also monetary policy for their spending projects, this could be a significant improvement to help ensure economic stability.
Sources:
https://www.privatebank.citibank.com/ivc/docs/quadrant/LATAM_Strategy_1129_Ver1.0.pdf