Recently there has been talk of preparation for a currency union between the Brazilian ‘real’ and Argentina ‘peso’ which would create the world’s second largest currency bloc. The new currency, which Brazil suggests calling the ‘sur’ (South) would reduce the reliance on the US dollar and encourage greater regional trade.
To enter a currency union it represents one end of the exchange rate continuum whilst the other end is pure floating currency determined by market forces (supply and demand) – see Fig 1 below:
By joining a currency union both Brazil and Argentina no longer have control over managing inflation, attaining full employment and use interest rates to respond to different stages of the business cycle. One of the benefits of a floating rate is that it acts as a shock-absorber – a downturn in the economy leads to a depreciating exchange rate and therefore more competitive exports and more expensive imports – however a lot depends on the elasticity of demand for both exports and imports. Remember the Greek experience in the EU when their economy was in a dreadful state financially and they had the Euro as their currency. If Greece still had its old currency the drachma it would have depreciated and maybe have led to some sort of export recovery. The concern was that the strength of the Euro was determined by the Germany economy and this impacted the poorer members of the currency union like Greece, Portugal and Spain. When asymmetric shocks occur they effect economies differently as they can be due to different production and consumption structures, trade exposure and varying levels of inflation between the two countries. This is apparent with Argentinian inflation hitting 95% in 2022 compared to 5.79% in Brazil. Furthermore, central bank interest rates in Brazil are 13.75% compared to the central bank in Argentina of 75%. It seems here that the Argentinian economy is in real trouble and add to this they are on the brink of another default on their debt – 5th in 40 years. So who is to benefit here – it seems that Argentina is in the worst predicament and might welcome currency union to try and improve the economic conditions in their economy. However will a full currency union actually happen? Table 1 below summarises some of the pros and cons.
Latin American countries are now struggling to control inflation and have succumbed to raising interest rates despite having slow growth economies. Inflation in this part of the world has a bad track record with Argentina, Bolivia and more recently Venezuela experiencing hyperinflation. Furthermore, these countries have been hit hard by the pandemic and their economy’s need to develop more economic growth to create jobs and higher incomes. Rising interest rates is the last thing they require especially after government stimulus programmes are winding down and the revenue from commodity prices is starting slow.
Latin America is struggling with the combined health and economic impact of COVID-19 than any other region. Inflation rates are currently – Brazil – 9.7% Venezuela – 5,500% Mexico – 6.1% Chile – 4.8% Peru – 4.95% Columbia – 4.4%
Source: FT – The spectre of high inflation returns to haunt Latin America. 11th September 2021
There is an old saying among economists: “throughout history there have been only four kinds of economies in the world: advanced, developing, Japan, and Argentina”.
The set of once-poor countries that are now rich include Japan, where the transition began more than 100 years ago, and some other East Asian countries such as Korea and Taiwan, whose transition started only 50 years ago and is now almost complete. But going the other way there is only one notable case of a country that started life relatively rich and ended up comparatively poor: this is the great puzzle or paradox of Argentina. In the late nineteenth century, it was among the top five countries in income per capita, richer than all European countries except Britain and on a par with other rich settler societies such as the United States, Canada, and Australia.
Japan and Argentina continue to confound macroeconomics. Below is a table comparing the Argentina and Japan at the moment. How different they are. It doesn’t look as if they will play each other in the Rugby World Cup as they are in different Pools. However if their macroeconomic conditions are anything to go by they should end up in the final
The Economist – Argentina v Japan – March 30th March 2019
Last week Argentina imposed currency controls on business to prevent money leaving the economy after the Argentinian Peso lost over 25% of its value since elections last month – see graphic. The central bank now require that:
exporters to repatriate earnings within 5 to 15 days
businesses will need permission to repatriate profits abroad or buy US dollars
residents are restricted to foreign exchange purchase of US$10,000 and non-residents US$1,000
With a track record of hyperinflation and financial crises, Argentinians are quick to sell their Pesos for US$ to maintain store value – with inflation and turmoil in an economy the local currency has less purchasing power. It is important for the Argentina government to restrict the demand for US$ and improve its ability to pay its significant debt – US$101bn. Capital controls have the aim of protecting the stability of the Peso and savers.
Will it work?
Although capital controls do stabilise the currency in a panic situation, they will only work in the long-term if they are used to confront the underlying macroeconomic problems in the economy itself. However, with Argentina’s inflationary issues coupled with fiscal deficits, capital controls are a band aid solution to the macroeconomic problems. Below is a very good video from the FT giving a background to the problems in Argentina.
Here is a clip from Nial Ferguson’s Ascent of Money that I used in my AS class today. It explains the hyperinflation problem that Argentina experienced in the late 1980’s – early 1990’s and reminds us of the dangers of inflation. Anyone who thinks that you can solve a financial crisis by printing money might be interested in the Argentinian experience.
Share prices and bond markets are moved by variables including market indicators and statistics on interest rates, inflation and unemployment. The variables are important in other ways, too. Interest rates affect mortgages, inflation harms those on fixed incomes and rising unemployment breeds job insecurity. Yet do many of us really understand how the figures are calculated? Do we really know how to interpret them? If we don’t, should we strive to know more?
We certainly should. Many commentators make a good living out of describing and interpreting statistics. Often their comments are commonplace and uninteresting.The pundit industry would collapse if we all knew more about these numbers and could judge them for ourselves. Interpreting market indicators is a minefield. Many indicators are official statistics that relate to economic performance. Although official statistics are usually honestly compiled, their accuracy varies.
While you can generally trust data published by, for example, Statistics New Zealand, you need to be aware of the limitations of the numbers. Take the consumer price index, a measure of “inflation”. Many commentators attach much greater significance to CPI figures than they deserve. The change in CPI from one month to the next may not be highly significant. It may be influenced by unusual factors that only applied in that month. Deducing a trend from one month’s figures can be dangerous. Statistics can also be adjusted and manipulated. Sometimes the adjustments are helpful. In the case of the CPI, for example, seasonal adjustments can be made. These reduce or eliminate the effect of items that vary sharply in price at different times of the year. They smooth out the figures, giving a better view of a trend. A moving average of several months’ figures may give a better view of an underlying trend. But neither of these is a panacea when it comes to interpreting the numbers. The less scrupulous might “annualise” one month’s or one quarter’s figures. But annualising can cause problems. If this month’s figures are sharply at variance with last month’s, then drawing conclusions from the annualised figure could be misleading. Argentina’s Inflation Rate
For the last few years the Argentinian government has published inflation figures that a lot of people find hard to believe. Expansionary fiscal and monetary policy has caused the economy to grow too quickly which eventually led to higher prices. In order to conceal the higher inflation rates the government resorted to price controls and tampering with the official figures. Some employees of the statistics institute, INDEC, were told to omit decimal points, not round them. According to The Economist, although this doesn’t seem much, when you do the calculations you get the following:
1% monthly rise in the CPI = 12.7% annual rise
1.9% monthly rise in the CPI = 25.3% annual rise
Unions in Argentina use independent statisticians when negotiating pay increases. Surveys from a university show inflation expectations running at 25-30%. When you compare the official (Government) and the unofficial (PriceStats – private provider of inflation rates) you get the following (see also chart from The Economist):
Unofficial annual rate – 24.4% and cumulative inflation since the beginning of 2007 at 137%
Unofficial annual rate – 9.7% and cumulative inflation since the beginning of 2007 at 44%
Confidence in the present government’s economic policy has taken a hit and it will have to earn back the trust of not only its people but also the global community.