South American Trade and Currency Volatility
Posted on: 08/06/2009 by phillips
This post is also available in: Spanish
Latin America has of some of the world’s largest countries, in terms of land area, but the continent has no large global economy, and only two medium-sized economies: Brazil and Mexico. The region also lacks a local hard currency as a basis for international, and especially intra-regional, trade.
Many of the commodities that South American countries export do not trade in the currency of the originating country. So, if Chile imports oil from Argentina or Argentina copper from Chile, they pay in U.S. dollars. A regional currency facilitates trade and the creation of financial service hubs.
Europe developed its financial services and its regional development bank around the British Pound Sterling, the German Mark, the French Franc, and its economic stability now depends largely on the Euro. The U.S. dollar filled this role in North America, and Asia uses the Japanese Yen (and increasingly the Chinese Yuan).1 The lack of a continental currency leads to unstable national currencies and also financial dependence, in this case on the U.S. dollar.
Three Latin American democracies are dollarized (Ecuador, Panama, and El Salvador). While the Bank of the South will not replace the use of the dollar, even in development projects, it could be a step in the right direction in terms of locally-sourced development infrastructure. It is also a step toward a South American regional currency. The Bolivarian Alternative for the Peoples of America (ALBA in Spanish) countries have proposed beginning with a SUCRE, a transactional currency introduced at the ALBA-TCP (TCP—Peoples Trade Agreement) conference in Cumaná, Venezuela in April 2009. SUCRE is a single system for regional exchange of payments; "Sistema Único de Compensación Regional de Pagos (SUCRE)."
ALBA itself was created as a "Bolivarian" alternative for Latin American commerce to oppose the Free Trade Area of the Americas (FTAA). Ecuador recently agreed to join ALBA.
Latin America is rich in real terms, however its financial infrastructure is primitive. This means that many national and international transactions pass unnecessarily via northern financial centers, sometimes requiring two hard currency conversions from buyer currency to U.S. dollar and from dollar to seller currency. Even transactions within a country can be in external currencies; buying an apartment in Buenos Aires, for example, involves a transaction in dollars. For a time this was also the case in Brazil. However, increased self-reliance, the strength of the Brazilian Real, and banking regulation have gradually replaced the dollar with the Brazilian Real in most Brazilian financial transactions.
One recent step forward has been a bilateral Central Bank agreement between Brazil and Argentina, allowing trade to occur between these two countries in local currencies. However, this Central Bank to Central Bank facility is not backed by basic financial services in Sao Paulo nor Buenos Aires, such as currency hedges to protect the transaction in the case of a sharp currency move between the Brazilian Real and the Argentine Peso (futures contracts in Brazilian real or Argentine pesos for example). With the global financial crisis, currency moves are becoming more volatile. The result is that traders pay extra to buy and sell futures on the U.S. dollar, which offers them the currency security they need to plan ahead and fix the price of a future transaction, so use of this new intra-central bank facility accounts for much less than 20% of transactions between Brazil and Argentina.
A History of Economic Instability
Latin America has experienced economic instability for centuries. Some economic historians believe this to be the result of bad habits inherited from colonial times. During the Spanish and Portuguese empires, export policies were policed by viceroys for the benefit of their Iberian kings (and corrupt local customs officials). With military conquest came exploitation of human and natural resources for export markets abroad. Iberian royalty cared little about the working conditions in their silver mines or large estancias.2 It never even occurred to them to pay for the silver and gold coins smelted there for use in Madrid or Lisbon which funded Europe’s development. In effect the coins were a donation of Latin American resources to Europe. New World plunder financed the development of Old World empires.
With independence came change and some improvement in the chain of international production. Recent decades, however, have seen another consolidation in the control of exploitation, production, transport, and marketing of South American resources. We have seen the introduction of new economic forces, a process known as the transnationalization of these economies. The chain of production has shifted to the hands of private transnational corporations. Among the most extraordinary example one might list U.S. transnational Cargill’s activities in grains and oils (especially soybeans) in Paraguay, Argentina, Bolivia, Brazil, and other countries in the region; or giant services corporations operating in the region such as Citibank, HSBC, Telefonica, Banco Santander, BBVA, and private oil transnationals such as Repsol.
Today none of South America’s commodity exports is denominated in South American currencies and most of the financial system is held and controlled by developed country-based transnational companies. This leaves national currencies and financial systems weak and vulnerable, what some have called a "neo-colonial" order that undermines regional development. This results in flows of capital3 from South America to the headquarters of the transnationals which operate there leaving the countries permanently short of hard currency. This is one of the causes of so-called stop-and-go economic instability cycles: (stop) crisis in the balance of payments, and then (go), the economy restarts after a currency devaluation—cycles of increasing poverty for those whose income is in the devalued currency. Stop-and-go makes development planning impossible. Devaluation makes debt more expensive.
Latin America’s economic problems are compounded by foreign debt and the growth of dollar-denominated commodity exports. This has a cyclical destructive pattern in Latin America from the shortage of savings in local currencies. Who wants to save for a rainy day when their currency is constantly losing value, if not by internal inflation, then by forced devaluation relative to other currencies? When Argentines have excess currency they ask their economist friends: "Should I buy Euros or dollars?" This means they have more pesos when the currency devalues and often means they can avoid taxes. On the contrary, in Brazil some save in foreign currencies, but due to recent economic stability and high interest rates, many save in Reals. This aids stability in Brazil but not in Argentina.
Much of Latin America’s debt began with "development" or "aid" loans made to the region via Multilateral Development Banks (MDBs) such as the Inter-American Development Bank (IADB) or the International Monetary Fund (IMF). Much of this money was used in Latin America to develop local infrastructure (typically destined to enable export of goods to countries outside the region) and to buy weapons for the military, but the "aid" money never left the lending countries—it was simply recycled into their arms manufacturers and construction companies.
President Chavez of Venezuela recently presented U.S. President Obama with a copy of Eduardo Galeano’s 1971 "Open Veins of Latin America;"4 the symbolism of open veins has a contemporary analogy in international finance. If the rivers of interest payments are dammed, they will stop pouring into oceans of foreign finance and instead can be re-channeled within Latin America. This could result in a constructive dynamic cycle of growth and currency stabilization. A regional bank such as the Bank of the South (BDS) could promote peace and economic development by the sourcing of development from neighboring countries. This is good for both source and destination countries. The net result is dynamic development cycles bringing benefits to the country in the region exporting the service. It also provides an aquifer of local finance that replenishes itself from local fronts.
To examine the cyclic destructive nature of the current lack of development, consider the following characteristics of Latin American public finance:
- High Cost Debt
Regional countries exhibit high debt-to-GDP (gross domestic product) ratios. They are indebted to countries outside the region and the cost of that debt has a high risk premium (country risk) also calculated by agencies external to the region. Much of their debt is in foreign currencies. All this combined makes the cost of debt repayments very high.5
- Exports Bring Dollars for Interest Payments
National governments are advised by neoclassical economists (such as those who work for the World Bank or the IADB) to counteract debt problems with economic policies that prioritize exports. This is compounded by the arguable theory that nations should only compete in exports in which they have natural competitive advantages over other nations. This in turn leads to policies to promote the export of commodities in primary form (from mining and agricultural sectors) while ignoring local industrial sectors that are not directly related to commodities and inhibiting the development of value-added industries.
- Transnational Export Trade, Not Denominated in Local Currencies
Many countries in Latin America compete with their neighbors in commodity exports. In mining these include oil, copper, gold, silver, and iron ore, and in agriculture, cattle, corn, sugar, bananas, soybeans, etc. Exports of these products to countries outside the region are characteristically transacted in foreign commodity markets, such as the Chicago Board of Trade6 with prices denominated in the U.S. dollar. Trade in commodities is handled by a small number of global transnational corporations competing with their own divisions in neighboring Latin American countries. Therefore, there is a tendency for exporters (those same transnational corporations and land owners in particular) to influence national governments in a race to the bottom, driving down national production costs by pitting neighbor against neighbor in devaluing national currencies. Competition for national economic activity also pressurizes neighboring countries to compete with each other. National governments are encouraged to provide production subsidies to export industries or to weaken environmental or labor laws, thereby enticing the presence of transnational production facilities to their country rather than to that of their neighbor. Examples include automobile production in Brazil and Argentina. It is interesting to note that while General Motors may be bankrupt it is still loath to sell its Brazilian plants, which are one of only a few profitable divisions in the company.
- Large Foreign Reserves Abroad, Less at Home
Managing devalued currencies and speculative attacks by currency speculators requires countries to maintain large reserves of foreign currency. The reserves are derived from exports (again largely denominated in U.S. dollars). This leaves smaller funds to pay off debts, and for internal development.
- Export Policies Push Down Currency Values, Debt Repayment More Expensive
Devaluations of currencies lead to high debt repayment costs for debt denominated in foreign currencies due to a lower tax-base in a devalued currency. This, in turn, has the unfortunate side-effect of high inflation due to increased costs of imports. It can even lead to internal social unrest due to unpopular taxation policies within the country. The current world financial crisis is leading to greater concentration of global wealth due to nations being forced to salvage their financial sectors by bankrolling private financial interests. While such problems are mainly in developed countries capable of the financial sophistication required, there are also risks in Latin American economies. Dr. Pedro Paéz, president of the Ecuadorian Presidential Technical Committee for the design of a new international financial architecture and coordinator of the Southern Bank, singled out competitive devaluations as a distinct risk, one that can be alleviated by trade policies based on regional solidarity, and not solely driven by raw competition. Such policies, along with policies of nationalization of critical economic sectors, fly in the face of the interests of transnational corporations operating across multiple Latin American borders. The ALBA system of trade, for example, has two primary tenets related to trade and production: Solidarity, complementarity,7 and non-competition, along with harmony with Mother Nature for long-term sustainability.
Dr Paéz’s own country has recently taken measures to escape the debt trap. Ecuador assembled a debt audit commission (Comisión Para la Auditoría Integral del Crédito Público, CAIC), an internationally advised national debt audit committee, in its department of finance. President Correa has refused to pay what the commission ruled on as fraudulent and/or onerous debt in an effort to break the debt/underdevelopment stranglehold that high debt repayments bring.
This has not made Ecuador any friends in the international financial community. Like Argentina or Iceland, the Ecuadorian default has led the country to be punished by "high country-risk" status, making traditional sources of investment and credit expensive or completely unavailable from New York, London, Berlin, Paris, and Tokyo. This lack of alternative funding makes creating an alternative source of development like the BDS even more attractive for the black sheep of international finance.
Toward Future Financial Integration
Having launched the BDS, regional leaders can choose to implement other modules described by President Correa above—a regional reserves fund and a common currency. These two elements would offer the region an opportunity to stabilize currencies relative to each other and prevent competitive devaluation, by loaning to each other in times of stress.
For a common currency proposal like the Sucre to develop into a transactional currency it will need the participation of Brazil and Argentina to gain international acceptance. For now, currencies are still national, and fiscal policy will be tight for the next few years. Latin America will have to look to alternative markets for loans, such as currency swaps with China or with each other.
Long-term stability will require savings and investment in Latin America even by Latin Americans. It will also require the development of basic financial services with local regulation. The BDS, regulated for its constituents and not solely for the benefit of its transnational corporations, can be used to fund genuine cross-border development projects for South Americans by South Americans. It is a promising step in the right direction for regional financial autonomy.
- As well as the U.S. dollar.
- Notorious examples include the silver mines of Guanajuato (New Spain/Mexico) and Potosi (Upper Peru, now Bolivia).
- The capital leaves as dividends, interest, and via pseudo-legal transfers to countries with lower (or no) national taxes, a process known as "transfer pricing" (simple definition: http://www.solhaam.org/articles/clm503.html) (Technical discussion re: U.S. transnationals: http://www.bdo.com/publications/tax/intlalert/LatinAmerTPpaper4-05-3.pdf).
- Video of presentation: http://monthlyreview.org/books/openveinslatinamerica.php.
- Example: the public debt to GDP ratio in Argentina grew from 29% to 41% between 1993 and 1998 and to 134% in 2003. Even after growth in GDP in Argentina of nearly 10% per annum since 2003, Argentina and Brazil both still have ratios above 50%.
- Complementarity: A term that is so alien to Anglo-Saxon finance that it is barely used in English, the Oxford dictionary defines it as a situation in which two or more different things enhance each other or form a balanced whole; http://www.askoxford.com/concise_oed/complementarity?view=uk.