This week, the two largest countries in South America announced they had begun talks on a common currency. Argentina and Brazil are to discuss the possibility of issuing a new joint currency and becoming the world’s second-largest currency block.

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It seems the two countries might be readying a currency tango…

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Many consider the adoption of the Euro in Europe far from being a complete success. Why would Brazil and Argentina consider such a union? What would they both get out of it?

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It has been initially suggested that the currency will not replace the current Brazilian real and Argentine peso but run in tandem, with hints that it will be called the “sur”. An official announcement is expected tomorrow when Brazilian president Luiz Inacio Lula da Silva visits Argentina for his first foreign trip since being elected.

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Currently, there are no plans that the currency would expand in such a way as the Euro with full fiscal union. It is being suggested that it will be only used for bilateral trade so as to reduce the dependency on the US dollar.

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The attraction towards a single currency for the Latin American region is clear. The region is a significant commodity producer including oil, natural gas, agriculture and metals. We have seen in the past few months, in particular as certain metals become crucial for global energy transition, that countries are looking to protect their exports. For example, Indonesia (which is the world’s largest exporter of nickel, crucial to electric car batteries) has suggested an OPEC-style cartel to manage the prices and supply of these highly sought-after metals.

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No no, not this type of cartel…

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A single currency for all of Latin America would give the region huge negotiating power with large economies that import many of the region’s exports such as the US, China and Europe. Many of the region’s exports are exported globally as raw commodities and then processed in developed economies.

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There is a huge price difference between the raw materials and their processed form, and more developed economies are imposing high tariffs on processed commodities to defend their industries. Forming a negotiating bloc for the region would give Latin America more economic sway in keeping these profitable processed industries onshore.

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These kinds of economic situations are the reason many smaller countries joined the European Union, so that with larger European economies on their side, they have more sway in negotiating trade and getting positive outcomes from economic discussions with large economies outside the Union.

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What if it were to expand to a broader fiscal union? It is clear to see that this would benefit Argentina more than it does Brazil. Argentina’s economy is perennially volatile, with the government regularly defaulting on its debt obligations. The country has defaulted on its debt nine times.

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Confidence in the Argentine peso has totally collapsed. Inflation in Argentina is currently at 94.8% which is mammoth compared to Brazilian inflation at 5.8%. Currently, interest rates in Argentina are 75% as compared to 13.75% in Brazil. Fiscally, the countries couldn’t be more different.

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A fiscal union would see Argentina benefit from Brazil’s more stable economic situation and inherit likely lower interest rates and inflation than it is currently having to deal with.

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In a similar vein, then Brazil would see its fiscal environment worsen as it has to share Argentina’s fiscal burden. Likely the reason why discussions are being limited to a currency simply used for trade with no fiscal union.

If the Argentinian situation is so negative from a fiscal perspective, then why is Brazil considering this currency at all? Beyond the additional economic influence, it might bring on the international stage, it is important to consider the economies of the two countries together.

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The two countries’ economies are hugely dependent, with massive levels of imports and exports between the two. These trades are usually done in US dollars, and Argentina has been finding it increasingly hard to buy dollars because of falling foreign exchange reserves due to its fiscal instability as discussed before. A new common currency eliminates these foreign exchange-related risks and stabilises trade between the two partners.

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Will this happen anytime soon? Certainly not, there is an awful lot to iron out before there’s any chance of a currency union. However, many believe this to be nonsense given such a significant difference between the two countries from a fiscal perspective. In my opinion, if we have managed to keep Greece and Germany in a union I don’t see why this is that far out of reach.