South America’s ‘Common Currency’ Is Actually about De-dollarization
Brazil and Argentina have announced that they intend to launch a currency union called the “sur” (the south). Economists were quick to point out that the two countries are far from being an optimal currency area. Argentine and Brazilian officials clarified that the project’s true ambition is to create a new unit of account (a synthetic currency like the International Monetary Fund’s Special Drawing Rights) for denominating bilateral trade and financial flows as an alternative to the U.S. dollar. Notwithstanding the near-universal dismissal of the proposal, the objective at its root—a reduced reliance on the U.S. dollar—is interesting to consider, even if highly unlikely to occur, at least in the medium term. In any case, a push for deeper economic integration in South America is a welcomed development because it could encourage well-needed faster economic growth.
There is no doubt that the initiative has some political appeal for the two countries in question; and in theory, monetary union could potentially make economic sense if some fundamental macroeconomic, legal, and political conditions were met. South America needs deeper economic integration to accelerate its development. Moreover, in a deglobalizing world—and with South America interested in acquiring autonomy from an increasingly introspective United States and a more assertive China—Brazil and Argentina might find it tempting to pool monetary sovereignty to acquire some monetary autonomy vis-à-vis the United States (there were also initiatives in that direction in Europe after the U.S. decision to withdraw from the Joint Comprehensive Plan of Action (JCPOA) and the treat to impose secondary sanctions on companies doing business with Iran during the Trump administration). In fact, as C. Randall Henning, a professor at American University, has argued, the euro was in part created to isolate Europe from the negative externalities of U.S. monetary policy. And it is widely recognized that it has been useful in that respect, even though it has yet failed to live up to its potential to meaningfully compete with the dollar as a global reserve currency.
On the economic front, Brazil and Argentina both have strong trade ties, similar productive structures (though the Brazilian one is stronger), and are major commodity exporters. However, inflation in Argentina is rampant—almost 100 percent in 2022—while in Brazil it is under control at 5.8 percent. Such a disparity is incompatible with a single monetary policy because it is unlikely that the economies of both countries would be stable with the same level of interest rate. In addition, this divergence reflects very different fiscal policy settings, which speaks to the need for political buy-in for monetary union and the policies that support it (i.e., fiscal unions and banking unions). Finally, the Mercosur agreement, created three decades ago to liberalize trade among Argentina, Brazil, Paraguay, and Uruguay, provides an institutional basis for the project. However, it works better on paper than in practice.
In any case, if the project is finally launched, the road will be difficult. Sharing a currency implies losing monetary and exchange rate policy as macroeconomic stabilization tools at the national level. As Eurozone countries learned in the last decade, this can be painful, and therefore, it should be clear that there is a political project behind it that most citizens support without fissures. In the case of Brazil and Argentina, where attempts of political and economic integration have not gone as far as in Europe and nationalism is entrenched, this is far from clear. Even if the two countries were to link the real and the peso in the first phase, what would happen if Argentina were to devalue? How would this affect the credibility of the project? The Europeans also introduced the ECU (the European Currency Unit) in the 1980s, but the anchor of the European monetary system was always the German mark. And it took over 30 years for European countries to launch the euro, which is still a work in progress.
The creation of the euro was a sui generis act that, for the time being, is virtually impossible to replicate elsewhere. The historical trajectory of Europe facilitated political integration after the Second World War. In addition, the balance of power in Western Europe is peculiar. The European monetary union is based on the Franco-German engine composed of two relatively even and complementary powers. The French economy represents 70 percent of Germany’s GDP, but France is a military power with a permanent seat on the UN Security Council.
This balance does not exist in other regions, implying that the smaller economies would likely have to surrender their economic policies to their much larger neighbor. For example, China is too dominant in East Asia, Saudi Arabia is too dominant in the Arabian Gulf (and the monetary union project in the Gulf Cooperation Council has stalled) and the same could be said of Brazil in South America. Argentina’s economy represents only 30 percent of the Brazilian economy and militarily it does not exert the counterweight that France has against Germany, not to mention its deep-rooted economic problems. Moreover, Brazil’s economic and monetary power is not comparable to that of Germany. In the absence of a fiscal and political union to support it, the euro, and the European Central Bank (ECB) were created on the basis of the credibility of the German mark and the Deutsche Bundesbank. The Brazilian Central Bank and the real lack this credibility. In the end, to create a stable common currency, it is essential to build a relatively independent supranational monetary authority, and that is not easy to achieve when the balance of power between its members is so asymmetric.
Finally, there is the geopolitical dimension. In a world increasingly marked by rivalry between great powers, Washington might not welcome a reduction in the use of the U.S. dollar in South America, especially given Chinese growing interest in the region. This could have serious consequences. The latest crises, both the 2008 financial crisis and the Covid-19 crisis in 2020, have shown once again that the Federal Reserve is still the world's central bank. Even the ECB, which issues the second global reserve currency, had to activate swap lines with the Fed to obtain the dollars needed to stabilize its financial system. The Fed has permanent liquidity lines with only five central banks: Canada’s, England’s, Japan’s, Switzerland’s, and the ECB, and during the crises it has extended temporary lines to nine more banks, including the Bank of Brazil (Argentina, for its part, received a similar liquidity line from the Chinese Central Bank). It remains to be seen whether the Fed will be willing to extend these swap lines in situations of financial stress if the “sur” is launched, especially if the true ambition of this initiative is to reduce the use of the U.S. dollar in the region, and if the Brazilian central bank loses prestige and credibility once it is linked to its Argentinian counterpart.
This is not to mention that the plan fails to recognize the reason that private (and often official) actors prefer to transact in dollars: the depth of U.S. financial markets, supported by legal and regulatory certainty, translates into an ability to affordably hedge exchange rate risk. Simply denominating contracts in a third currency will not help manage exchange rate risk or encourage trade. This is especially true because Argentina and Brazil do not exist solely in a closed, two-country system, but rather in a global economy where economic actors transact with the rest of the world.
In short, the proposal for monetary integration between Argentina and Brazil seems to be to create a synthetic unit of account for financial and commercial trade, which would aim to reduce operational costs and isolate their economies from shock coming from U.S. monetary policy. If successful, this project could be a stepping stone toward a common currency that could reduce the intense dollarization of the region, especially acute in Argentina. Moreover, it shows that the arrival of Luiz Inácio Lula da Silva to the presidency in Brazil has the potential to trigger deeper economic integration in South America. However, the project is likely to fail. As the long and complex European experience shows, a monetary union cannot be sustained without a minimum degree of fiscal union that can cushion the asymmetric shocks that may impact the different parts of the union. If that is the ultimate objective, this is a project whose progress will be marked over decades and well beyond the terms of politicians currently in office.
Federico Steinberg is visiting fellow with the Europe, Russia, and Eurasia Program at the Center for Strategic and International Studies in Washington, D.C and a senior analyst at the Royal Elcano Institute. Miguel Otero-Iglesias is a senior analyst at the Royal Elcano Institute.