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January 24, 2023

Brazil & Argentina To Explore Common Currency

South America's two biggest economies look at possible shared currency.

Brazil and Argentina will consider a common currency as part of ongoing plans to facilitate trade between the two countries.

Brazil-Argentina-Explore-Common-Currency

The leaders of South America's two biggest economies will meet in Buenos Aires this week to consider plans for greater economic integration. One important topic will be initial talks on establishing a common currency, tentatively called the “sur” (south). President Lula of Brazil and President Fernandez of Argentina released a joint statement saying they would "advance discussions on a common South American currency that can be used for both financial and commercial flows."

The two countries have historically been closely linked and are each other's largest trading partners. 

Argentina has suffered from high inflation and a rapidly declining currency. The Argentine peso has dropped over 50% against both the dollar and the Brazilian real in the last year. This disruptive movement has harmed trade between the two countries, so a policy to foster currency stability would be welcome. A stable currency would also generate more liquidity in the peso spot and forward markets.

Implementing a common currency would require a significant amount of coordination and cooperation between the two countries, including the alignment of their monetary policies, exchange rates, and inflation rates, which will prove challenging. 

The shared currency could be expanded to include other major South American economies. Over time, the result could be a much less important role for the US dollar. Some economists have said they envision the sur becoming the “euro of South America.”  A shared currency would likely encourage more travel and trade between the countries of South America as the euro has done for the countries of Europe.

Biggest Challenges to Economic Integration:

  1. Countries sharing a currency give up the ability to tailor monetary policy to their needs. They can't unilaterally devalue their currency to boost exports or lessen debt loads.    

  2. Brazil and Argentina are at different levels of economic development, so major adjustments will have to be made by both parties for an agreement to work.  

  3. Despite having a long history of friendly relations, both countries have a history of political instability, which could make it challenging to maintain a shared currency as regimes inevitably change over time. 

  4. Global acceptance of currency for international trade. A challenge will be getting major energy producers like OPEC and Russia to accept payment in the new currency for international energy transactions.  

Takeaways:

  • Improved economic stability: A shared currency would help stabilize the economies of both countries, as monetary policy would be coordinated and inflation rates would be more closely aligned. Foreign investment in both countries would likely expand, contributing to growth in each of their economies.

  • A step towards “de-dollarization”:  Many countries have recently experienced problems with the strong dollar and its effects on trade and debt. Having another means of exchange could result in less reliance on the US currency as the basis for international trade, eliminating many of the problems associated with using the dollar.

  • It will take time: The European Union took many years to get from the drawing board to implementation. It is expected that any South American currency union would entail a gradual process that would be slowly developed over time. A shared currency could be the basis for better political relations and more efficient distribution of economic resources.

Dive Deeper: Is this setting a new philosophical precedent?

Is this setting a new precedent? In some ways yes, in many ways no. The euro already established the precedent of a shared currency and coordinated monetary policy. The euro has now survived over 20 years and has generally been considered a success. 

However, there have been numerous problems related to debt management and spending by individual countries, but the European Union has so far managed to work through all issues. Most importantly, this experiment hasn't been translated to another region of the world with any success. Starting with just two countries makes the South American currency experiment easier to manage, and other countries can be gradually added over time. 

Should Brazil and Argentina successfully merge their currencies, this is precedent setting in that this has only succeeded in one area of the world, but is a model that can be adapted and utilized beyond the EU, or even South America. Pangea has often believed that there is an inevitable expansion of liquid and usable currencies beyond the G10, but a simultaneous consolidation of currencies to facilitate better liquidity, and therefore reduced volatility. Time will tell.

The potential monetary union of Brazil and Argentina is representative of the evolving nature of international business. Companies that want to thrive in a changing environment must be prepared to adapt. Preparations should include plans for managing (i.e. hedging) the new risks that will undoubtedly emerge.  Pangea will be here to offer a full suite of currency hedging strategies and resources to help our partners navigate an ever-changing global economic landscape.

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