Argentina and Brazil currency union – pros and cons

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:

Reserve Bank of New Zealand: Bulletin, Vol. 68, No. 4

Costs and Benefits

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.