International Policy

A Common Currency For South America?

Economists are contrasting the fiscal and monetary plight of Brazil with its neighbor, Argentina. The Brazilian government has a large fiscal deficit, interest rates are up, short-term debt is burgeoning and there have been rumors its currency, the real, will be devaluated immediately after the October presidential election.

By contrast, in Argentina, after two rounds of hyperinflation:

  • A new monetary system was implemented in 1991 based on a fixed, one-to-one exchange rate with the U.S. dollar, free capital mobility and strict constraints on the central bank.

  • Under this "convertibility" system, 100 percent of Argentina's monetary base is backed with foreign exchange, and the central bank is forbidden to grant the government credit.

  • As a result, interest rates are low, the government's cost of borrowing is about 8 percent a year (half that of Brazil's), inflation has disappeared, growth resumed and unemployment is declining.

Some economists recommend that the South American nations in the Mercosur free trade group -- Argentina, Brazil, Uruguay and Paraguay -- adopt a common currency based on the Argentine convertibility system, as Argentina's President Carlos Menem has proposed. They say this would help prevent a currency crisis and economic chaos in Brazil.

Source: Sebastian Edwards (University of California - Los Angeles), "How About a Single Currency for Mercosur?" Wall Street Journal, August 28, 1998.

 

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