The currency dream of the neighbors is pure wishful thinking

The dollar is used for about half of world trade, about half of the world’s debt is denominated in US dollars, and about 90 percent of all foreign exchange transactions are in dollars. Denial of access to the dollarized system – like Russia was when it was booted out of the global financial messaging system SWIFT – underpins America’s power to impose financial sanctions.

Russia and China are now trading directly in their own currencies, China is trying to encourage the internationalization of the yuan, and even the Saudis have declared that they are open to trading currencies other than the dollar after weighing oil prices for nearly half a century exclusively in dollars.

While in principle it might make sense for South American economies to trade their local currencies to reduce their dependency and economic and political vulnerability to the dollar, the practical obstacles to even a modest form of monetary union seem overwhelming.

Brazil and Argentina have explored the concept of monetary union before, with discussions of a common trading currency called the “gaucho” going back as far as the 1980s.

The biggest hurdle to even a limited form of monetary union is the mismatch between the two economies and their monetary policies.

Brazil is the strongest of Latin American countries, with an economy of US$2 trillion (US$2.8 trillion). It has an independent central bank and has had an inflation rate of less than 6 percent since the pandemic began, despite sharp currency depreciation.

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With an economy half the size, Argentina has been an economic basket case for decades. It has defaulted on its debt nine times in its history, most recently in 2001, and was only bailed out in 2018 by the International Monetary Fund (which it still owned more than $40 billion).

Its central bank is not independent of the government and essentially just prints money. Argentina’s inflation rate is expected to reach 100 percent this year. That would not be a record – in the 1990s it was 3000 percent.

Argentina has few foreign exchange reserves, which probably explains in large part why Brazil is interested in the common currency project. Forced to ration the use of its reserves by imposing capital controls, Argentina cannot use them to support trade, limiting opportunities for Brazilian exports to its largest South American trading partner.

That would suggest that even in a very limited monetary union (and it’s unclear why exporters from both countries would want to accept surs instead of US dollars when most of their imports come from outside Latin America) Brazil and its monetary policy would dominate.

Presidents have indicated that their long-term dream is something closer to a regional currency bloc similar to the eurozone.

It took decades of trade policy alignment, a decade of preparation for the introduction of the euro, and three years of the euro being an “invisible” currency, used more for accounting and electronic payments than a widespread medium of exchange, before the eurozone went live .

Even then, the history of this block revealed its weak points. Without near-identical fiscal and monetary policies, cracks have emerged in the eurozone, with Germany and the other stronger northern European economies being forced to bail out and prop up the weaker and less fiscally disciplined southern European economies like Greece and Italy.

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With even more divergent economies in Latin America and less global influence—Brazil and Argentina together account for perhaps 3 percent of global GDP and all of Latin America about 6 percent, compared to the eurozone’s 14 percent—even if the presidents realized their long-term vision, would have this has no significant impact on the world economic order.

The mechanics of the far more limited version of a monetary union that countries are considering have not yet been spelled out in detail and could take years to develop.

There have been suggestions that the sur could be constructed as something like a stablecoin or the “special drawing rights” used by the IMF, creating a digital currency whose value would be fixed and backed by a basket of commodities and currencies.

An interesting idea is a monetary union between Brazil and Argentina, which could eventually be extended to other South American economies. However, without massive structural reforms of their economies, particularly Argentina’s, this seems more wishful thinking than something achievable.

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