Beware bewitching single currency dreams

Luiz Inácio Lula da Silva, Brazil’s president-elect, is resuscitating the dream of a Latin American single currency. It’s an idea that plays well on the campaign trail, but it would be a disaster in practice.

Why it matters: The tensions between economics and politics tend to run high in Latin America, which has a long history of disastrous monetary policy.

  • The current status quo, where most countries have free-floating and relatively stable national currencies, is by historical standards pretty successful. Dismantling it for political reasons would be a very bad idea.

How it works: The theory of optimal currency areas was first fleshed out in 1961, in work that eventually won a Nobel Prize for Robert Mundell. In order for a single currency to be a good idea, four facts have to obtain:

  • Free movement of labor
  • Free movement of capital
  • Fiscal policy that transfers money from rich areas to poor areas
  • Broadly synchronous business cycles.

The big picture: Even a small Latin single-currency area would only satisfy one of the four criteria — there are definitely countries that could negotiate free movement of capital.

  • Open borders, however, where someone from, say, Paraguay would be free to live and work in Chile, are a non-starter.
  • Similarly, Uruguayans are not going to want to send large annual sums of money to Bolivia.

As for business cycles, an influential 1993 paper by Barry Eichengreen looked at cross-correlations between 11 different Latin American countries. Of the 55 possible pairings, only four showed significant positive correlations.

  • Those findings were upheld by later analyses in 2003and 2018.

The bottom line: It’s easy for politicians to say that a single currency would help give Latin America more economic weight versus the U.S. dollar. In reality, however, it would probably just cause painful internal ruptures, just like we saw within the Eurozone in 2011.


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