By Sonja Rijnen-
Brazil and Argentina made headlines earlier this year after appearing to get the ball rolling on the creation of a common currency that could have led to the world’s second-largest currency union. Despite initial excitement, Mexico’s president quickly stated that his country would not join such a currency union and it appears that the focus is more on a common unit of account for bilateral trade between the two largest economies in the region. Although the project for a regional common currency may not come to fruition yet, there are various opportunities it would bring if it did.
The most obvious opportunity would be the facilitation of trade. In general, trade currently makes up a small portion of the region’s economies. Argentina and Brazil are relatively closed with trade representing 33%and 39%ofGDP respectively, the global average being 57%. Latin America does not only not trade much with the rest of the world but it also has low levels of intra-regional trade and integration, although not for a lack of trying. The introduction of a common currency would encourage Latin American countries to trade more among themselves as exchange rate volatility would be eliminated and the exchange of goods and services would be cheaper.
Trading with your neighbours helps establish successful supply chains which can make countries more competitive on the global market. If Latin American countries increased intra-regional trade, the volume of goods and services they would exchange with the rest of the world would also likely increase, helping countries catch up with other emerging economies.
A second opportunity a common currency would bring to the region is a decline in its reliance on the US dollar. A more stable and robust regional currency would likely lead to less pressure on Latin American central banks to hold large reserves of US dollars to make international transactions. The recent appreciation of the US dollar compared to Latin American currencies (in part stemming from historic inflation combating interest rate hikes in the US) has made the purchase and repayments of dollars increasingly expensive for many countries. This is not a new problem and rapid rate increases in the US were partly to blame for Latin America’s debt crisis of the 1980s, referred to as ‘The Lost Decade’. Reduced reliance on the dollar could help Latin America avoid history repeating itself.
A final, less obvious, opportunity a Latin American common currency would bring is the fact that integrating monetary policy and having one regional central bank could help with monetary stability. A 2022 IMF study of 17 Latin American countries showed 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 central governments.
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 and where politics is increasingly moving towards the extremes, this could be a significant improvement to help economic stability.
Sources: https://www.imf.org/en/Publications/WP/Issues/2022/09/16/Central-Bank-Independence-and-Inflation-in-Latin-America-Through-the-Lens-of-History-523542 https://www.privatebank.citibank.com/ivc/docs/quadrant/LATAM_Strategy_1129_Ver1.0.pdf