Currency

Since the mid-nineteenth century, monetary instability has proven a major hindrance to Latin America's economic and political development. Internal political and social disruptions have frequently interfered with the ability of Latin American nations to implement and adhere to the sound economic policies that underlie stable currencies. At the same time, the capacity of many Latin American nations to promote monetary stability was hindered by their economic over-reliance upon the export of raw natural resources and the intake of foreign direct investment, making the region highly vulnerable to external shocks caused by factors such as investment cycles and global recessions.

Economic theory postulates that strong currencies tend to benefit domestic industry and consumers by improving access to international credit and lowering the real cost of imported consumer and industrial goods, whereas weak currencies encourage export activities by reducing the international prices of export goods. Governments maintain some control over currency valuations through their ability to adjust key interest rates, monetary supply, investment and trade restrictions and incentives, and foreign reserve deposits. To a large extent, however, currency valuation is determined by trade balances and public confidence in the governing authority that issues and guarantees the currency.

HISTORY

Following the Spanish wars of independence in the early to mid nineteenth century, the newly minted currencies of the young Latin American nations fluctuated wildly in response to the sporadic fighting among local elites, heavy debts incurred from years of military expenses and treasury-plundering caudillos, widespread infrastructure destruction, and vulnerability to the boom and bust cycles of the rapidly industrializing markets of Europe and the United States. Although Brazil's separation from Portugal proved less destructive, its currency also suffered tumultuous swings in response to a series of regional revolts and sustained dependency on exports.

As the situation stabilized during the latter half of the nineteenth century, foreign direct investment flows increased, the banking sectors expanded, and some countries—notably Mexico, Argentina, Brazil, and Chile—raised tariffs and implemented devaluation policies (raising interest rates and paying down debt when feasible) to encourage industrial growth and modernization. While heavier investment led to modernized transportation and communication systems, it also produced escalating national debts, engrained bureaucratic corruption, periodic bouts of inflation, and bank crises. Frequent and intense monetary policy shifts between alternating political administrations backed by industrial proponents and the traditional agricultural landowning class further undermined public confidence. Revolutions and populism, periods of military dictatorships, and persistent vulnerability to international commodity markets resulted in unsustainable public debt, bouts of hyperinflation, the repeated introduction of new national currencies, bank runs, and public confidence crises in Latin America through much of the twentieth century.

TWENTIETH-CENTURY REFORMS

Since the 1990s, however, many nations have introduced innovative and effective reforms to restore confidence. Between 1991 and 1994, Mexico, Peru, Argentina, and Brazil all introduced new currencies to break the inflationary crises provoked by the poor economic administration of their predecessors, and augmented the purchase of dollars for their foreign reserves to support the value of these currencies. These policies were supported by the greater independence granted to federal bank ministers. Two of Latin America's most poorly administered economies, Ecuador and El Salvador, took the unprecedented step of adopting the U.S. dollar as their national currency.

Higher industrial growth and foreign direct investment followed, but these policies also left the nations more vulnerable to global monetary shocks. The downward spiral began with Mexico's failed attempt to manage a currency devaluation, which sparked the 1994 peso crisis. The "tequila effect" that followed and the subsequent financial collapse of Asian and Russian markets led international investors to yank so-called hot money investments from emerging markets. Brazil and Argentina responded by raising interest rates as high as 40 percent to defend their currencies, resulting in higher debt levels and sharp spikes in unemployment. Brazil and Argentina eventually conceded to floating their currencies in 1999 and 2001, which initially led to sharp devaluation and some inflation. Subsequently, however, strong fiscal administration and high commodity demands driven by emerging market growth inspired international investor confidence and enabled leaders to control inflation while lowering key interest rates, boost social and infrastructure spending, and pay down large amounts of foreign debt. Unfortunately, relatively tepid gross domestic product (GDP) growth and continued wealth imbalances increased political discontent with incumbent leaders. The question remains as to whether Latin America is entering a new era of industrial-led growth and monetary stability, or if a new wave of populism and the inevitable decline of international commodity prices will once again upset the balance.

See alsoEconomic Development; Foreign Investment.

BIBLIOGRAPHY

Elson, Anthony. "What Happened? Why East Asia Surged Ahead of Latin America and Some Lessons for Economic Policy." Finance and Development 43, no. 2 (June 2006): 37-40.

Topik, Steven. The Political Economy of the Brazilian State, 1889–1930. Austin: University of Texas Press, 1987.

Zarazaga, Carlos E. "Argentina, Mexico, and Currency Boards: Another Case of Rules Versus Discretion." Economic and Financial Policy Review, Federal Reserve Bank of Dallas (fourth quarter 1995): 14-24.

                             Christopher L. Murchison