Getting to monetary integration in Latin America

04-02-2023 10:56 AM
Camila Villard Duran

Brazil and Argentina have announced plans to launch technical studies aimed at laying the groundwork for greater regional financial integration, with the ultimate goal of creating a common currency, called the “sur” (south). While the goal may seem distant, it is far from impossible.

For now, the sur is less a concrete project than a symbolic statement. It is a political call for independence from the US dollar, whose dominance in the global trading system grants the United States what Valéry Giscard d’Estaing, then France’s finance minister, famously called an “exorbitant privilege”, and US-led international payments platforms, such as the SWIFT financial-messaging system.

Ultimately, however, it is a practical goal, shared by recently elected Brazilian President Luiz Inácio Lula da Silva and his Argentinian counterpart, Alberto Fernández. Relying on a third currency, the dollar, to settle trade payments and financial transactions decreases efficiency and increases costs. In an increasingly fragmented world shaped by great-power competition, it also leaves countries vulnerable to geopolitics-driven policy changes. The sur is meant as a kind of “exit strategy”, a means of escaping the current global monetary (dis)order.

International news reports have tended to focus on the prospect of a euro-style currency that replaces Latin America’s national currencies and is governed by a common monetary policy. But as Brazil’s current finance minister, Fernando Haddad, explained last year, the sur would function instead as a shared unit of account, with a regional clearinghouse settling reciprocal obligations among the member countries. The official statements on the sur from both Argentina and Brazil echo this conception, noting that they are not seeking to replace the peso or the real, respectively.

Establishing a regional unit of account that acts as a credible alternative to the US dollar will require a combination of strong political leadership and effective leveraging of technological innovations. A shared unit of account would eventually evolve into a new type of money, which could take the form of a tokenised sur for private transactions.

Economic history bears this out. After the US abandoned the gold standard in 1971, effectively “floating” the dollar, a period of financial innovation began, with different units of account being created, in order to support monetary stability within regions. The most notable example was the European Currency Unit, the precursor to the euro, which entered into operation in 1979.

The ECU comprised a basket of European currencies, and its value was used to determine the exchange rates and reserves among the members of the European Monetary System. It was supported by the European Monetary Cooperation Fund, which had been established in 1973 to foster stability and cooperation within the European Economic Community, not least by administering the EEC exchange-rate system and reciprocal credit facilities.

The EMCF relied on mutual financial support among its participants. Moreover, the Bank for International Settlements acted as a financial agent for the Fund, concluding temporary currency swaps for EEC central banks. This involved transferring official ECUs in exchange for a country’s contributions in foreign-exchange reserves.

This points to a critical lesson for Latin American leaders as they attempt to develop the sur: credible regional and national monetary institutions are essential. To that end, countries must work to build mutual trust, starting now.

At the same time, Latin American countries should work to strengthen the institutions that are already in place, namely, the Local Currency Payment System, which was established in 2008 and includes Argentina, Brazil, Paraguay and Uruguay. While this payment infrastructure is not based on an alternative unit of account, it can help set the institutional stage for the creation of such a unit, while bolstering member economies, but only if it is expanded and improved.

Economic history also suggests that markets, not states, steer the development of new forms of money through innovation. In the case of the ECU, the official unit of account effectively became a currency: the so-called private ECU. But there were no state-issued coins or paper money. Rather, private ECUs functioned legally as bank liabilities, the value of which was pegged to the ECU basket exchange rate. The private ECU also gave rise to other ECU-denominated financial vehicles.

As Michael Bordo and Anna Schwartz have argued, imaginary or embryonic forms of money, such as the ECU, are market responses to an economic problem “brought about by limited technology and fragmented and weak political power”. Today, however, technological constraints are significantly less confining. Innovations like Distributed Ledger Technology (DLT) are revolutionising monetary and payments systems as they attempt to reduce risk and boost efficiency.

The Latin American proposal should build a bridge between the sur and new ideas concerning the interoperability of central bank digital currencies (CBDCs) and DLT for cross-border transactions. Central-bank cooperation and technological exchanges will be crucial to reduce costs and inefficiencies, thereby enabling the creation of a regional financial architecture.

Brazil’s central bank is already laying the groundwork for success. Beyond creating Pix, a platform for local payments that is recognised worldwide, it has presented an “innovation agenda”, which includes open finance and a CBDC. The wholesale CBDC project, in particular, is needed to buttress the financial market infrastructure and connect it to other frameworks, including DLT platforms, at the regional and global levels.

For Latin America, the main innovation would be the creation of a “private sur”, sustained by credible state commitments and regional monetary institutions, which could evolve into tokenised assets that market actors could trade on digital platforms. To achieve it, Argentina and Brazil should continue to lead the way. In particular, Lula, with his status, drive and charisma, can champion a more effective regional dialogue focused on devising viable proposals for monetary cooperation, boosting trade, and advancing financial integration.

Camila Villard Duran is an associate professor of law at ESSCA School of Management. Copyright: Project Syndicate, 2023.

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