How Can Latin America Compete in the Foreign Exchange Market?

The presence of Latin American currencies in the foreign exchange market is rather weak, due to various factors, such as the stability of the economy, devaluations and inflation in the countries of the region. But can anything be done about it? Can they increase their participation in the foreign exchange market, becoming competitive?

Global foreign exchange market

As is known, unlike stock exchanges, the foreign exchange market is not regulated, there are no intermediary entities. Each transaction is an agreement between the parties, although there may be agents who intervene, on behalf of said parties.

Now well, the volume of transactions depends on the clients’ need for foreign exchange, to carry out commercial transactions or, simply, of what is bought and sold, to invest and earn.

In the same order of ideas, although the world currency market does not have a center, there are nerve points. New York, London, Tokyo, Frankfurt, and Zurich are among the cities where the largest volume of operations is concentrated.

Overview of Latin American currencies

Cities in Latin America are not mentioned in the above list; as well as their currencies are not counted among the most traded pairs, a category where the euro, the dollar, the yen, the pound, the Swiss franc dominate.

This still seems like a paradoxical situation. But why does it happen? Let’s look at some factors that may contribute.

Strength of the currency

Among the first reasons why a currency is more traded or used is its strength. In this sense, Latin American economies have a serious handicap, due to the constant devaluations.

To mention a few examples, in 2022 the Argentine peso lost 41.4%.; the Mexican peso, on the other hand, lost 20% between the end of 2022 and the beginning of 2023. And we are talking about two of the largest economies in the region.

Country confidence

Secondly, there is the general confidence in the country’s economy. Usually, those who are going to invest prefer a solid currency, which protects their money, and not the opposite. But Latin American economies sometimes do not inspire too much confidence to the investors.

Contributing to this are the ever-present inflation, the unstable political situation, decisions that do not favor investment, and measures such as exchange controls or limits on daily amounts.

How can Latin America compete?

The most obvious answer to this question would be we must have a strong currency. But this in turn generates other questions, regarding the way or ways to achieve it. Let’s see.

A single currency

Recently the possibility of creating a single currency for the region has been put back on the discussion table. Although the idea is not new, apparently now it is not just a proposal, but a first step has already been taken.

Indeed, before the VII CELAC Summit, held in Santiago de Chile in January 2023, the presidents of Brazil and Argentina, Luiz Inácio Lula da Silva and Alberto Fernández, made the official announcement to start working for a unitary currency, to initially facilitate bilateral trade.

The proposal is expected to transcend the scope of these two nations, in the sense that other countries are expected to join the initiative of the Community of Latin American and Caribbean States. However, this path is not short, nor will it be free of obstacles, because many things are needed to achieve it.

In some research the feasibility of a possible monetary union in the region has been questioned, as it is considered that the countries of the region do not have the capacity to maintain or stabilize their balances of payments and be solvent in relation to their debts; besides that their economic models differ from each other.

The other option: dollarization

Another alternative that is proposed to have a strong currency in the region is not to create it but to adopt one. In this case, it is the dollar, a currency that maintains a fairly close relationship with the economies of Latin America, to the point that it has been used, officially or unofficially in some countries, such as:

  • Panama: adopted the currency in 1904, in the context of the relationship raised by the opening of the canal, whose main beneficiary were the United States.
  • Ecuador: beginning in the year 2000, the government of Quito played the card of dollarization to save a hyperinflationary economy that seemed to have no way out. Despite the initial rejection of the measure, it was eventually accepted, and it is claimed that, thanks to this, inflation has remained below double digits.
  • Venezuela: Venezuela is in a worse situation than Ecuador, where price increases have broken all existing records. Although the bolivar is still the official currency, the prices of most items are set in dollars, and this currency is also in current use.

    Given the greater confidence generated by this currency, dollarization can be the solution to some problems of the economy, such as avoiding depreciation, reducing capital outflows, reducing the country-risk value, favoring investment and stability.

    But, as for its participation in the global foreign exchange market, for Latin America it would mean not having any identity. It would be like going to the Olympics, but under a different flag.

    And it is that a dollarized country simply loses its monetary sovereignty, as well as the control of the circulating, since it is not the one who prints the banknotes, reducing in turn the options to finance public spending.

    Monetary Council

    According to a study, dollarization has its benefits, since it not only sends good signals to the market and investors, but also forces the country’s government to assume greater fiscal discipline, manage its debt better, reducing risk, increasing investment and growth.

    However, these same objectives can be achieved by adopting a Monetary Council, in this case for Latin American countries. The mission of this entity would be to set exchange rates, under the principle that each unit in circulation is backed by international reserves or by the nation’s treasury.

    Strengthening the economy

    Despite its dollarization and low inflation, Ecuador has also had to resort to the International Monetary Fund. No matter what your currency is, commodity-exporting countries are vulnerable to price declines in international markets. And this is the case for most of Latin America.

    Similarly, this dependence affects the economy and, of course, the value of the currency. By the way, for 2023 growth expectations in the region are not encouraging.

    In order for Latin America to compete in the foreign exchange market, with a strong currency, backed by a solid economy, its foundations must be strengthened: balance of payments, freedom of entrepreneurship, clear rules, transparency in administration, support for industry…
    These are words that we all know, necessary for the ideal conditions to take place. However, the usual question is: who puts the bell on the cat?

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