InsightsDollar scarcity in Argentina and Brazil

Dollar scarcity in Argentina and Brazil

Could the possibility of a “currency union” between Argentina and Brazil solve the shortage of dollars affecting both countries or trigger a severe recession?

Two proposals from the Southern Cone

On 22 January, the presidents of Argentina and Brazil issued a joint statement on the possibility of a “currency union” between the two countries. The following day, Brazil’s Minister of Finance, Fernando Haddad, announced that, as a first step, the Bank of Brazil (a government-owned commercial bank) would finance all Brazilian goods and services imported by Argentinian companies in 2023, through loans denominated in BRL.

Senior figures from both governments explained that these two proposals had been developed in an attempt to solve “the shortage of dollars” that is afflicting the two countries, which they attributed to Covid-19 disruptions, the war in Ukraine, and the current restrictions imposed on the creation of dollars by the US Federal Reserve.

The announcements garnered much interest from many other Latin American countries affected by the scarcity of dollars. They thought the proposals would reduce the need for dollars to finance trade between South American countries, leaving their dollars only for purchases from other countries. Yet, after just a few weeks, the initial interest has faded because the proposals do not address the causes of dollar scarcity and therefore cannot resolve it. Instead, the announcements called attention to the possibility of a currency crisis that would trigger a severe recession in the two largest economies in the Southern Cone. 

The cause of the problem

The so-called dollar scarcity, affecting many emerging markets, coincides with the contractionary policy of the US Federal Reserve and was widely predicted when interest rates started to increase again. As has happened before, markets fully expected dollars abroad to begin flowing towards the US as interest rates rise: the flight to safety. Yet, the dollar scarcity in Argentina and Brazil (particularly in the former) began long before the US Federal Reserve contraction began. Therefore, the cause of the dollar shortage in Argentina and Brazil is internal to these economies.

Scarcity comes at the end of a chain of events that starts with excessive fiscal deficits. The chain goes like this: (1) the government spends too many pesos, so (2) the central bank prints too many pesos to finance government expenditure, which causes (3) a rise in dollar purchases because the things that people buy with the money created by their central bank contain significant imported inputs. Thus, the more domestic credit is created, the more dollars are used to pay for imports. Equilibrium is reached when the demand for imported goods and services can be met with proceeds from exports and market-driven capital inflows. The situation becomes critical, however, if the banking system’s ability to pay for imports declines to a point where the availability of imports becomes the bottleneck for domestic production. This happens when domestic credit grows too fast, leading to unsustainable dollar outflows. While Argentina and Brazil are getting there, the former seems closer to that dangerous situation. It is so close that Brazil is afraid that Argentina will not be able to get the dollars required to pay for its imports from Brazil and is offering to finance them not in dollars but in BRL.

As shown in Figure 1, both Argentina and Brazil are showing a persistent decline in the ratio of the banking system’s Net Foreign Assets to its domestic credit.

SOURCE: International Financial Statistics, International Monetary Fund.

This trend is unsustainable in the long run. If net foreign assets keep falling as a percent of domestic credit, eventually they will be insufficient to pay for the imports needed to sustain domestic production. At this point, countries experience currency crises resulting in reduced output. Usually, when governments get to this situation, they ask for help from the International Monetary Fund (“IMF”). The IMF provides dollars to finance imports but does it in exchange for promises to reduce the growth rate of credit so that a new equilibrium between net foreign assets and domestic credit is reached. This adjustment also reduces the rate of growth of the economy.

Thus, excessive monetary creation reduces output via currency crises or IMF intervention. The only sustainable solution to this problem is to reduce domestic credit before it leads to a currency crisis, which means reducing the fiscal deficit, immediately. This is particularly difficult in Argentina, where domestic credit has been growing at incredibly high rates (90% in 2022), mainly to finance the fiscal deficits.

The proposed solutions—to finance Argentinian imports from Brazil in BRL or to create a new currency—would only worsen the problem.

The financing of Argentinian imports from Brazil

While the previous figure shows that both countries suffer from dollar scarcity, other indicators show that the Argentinian situation is the worst. Argentina has been able to keep its Net Domestic Assets from a total collapse only by devaluing the peso against the dollar by 73% in 2022 while the real appreciated by 7% during the same period. The net result has been an 85% devaluation of the peso to the real during that year.

This means that even if the Bank of Brazil charges zero interest rates to its Argentinian customers, these still would be paying the equivalent of 85% interest rates to cover the devaluation of the peso relative to the real. This assumes that the peso’s rate of devaluation relative to BRL would remain at 85% per year. As Figure 2 shows, however, the rate of devaluation increased from 29% in early 2022 to 85% in December of that year. All other variables have moved in the same direction. Domestic credit grew 90% from November 2021 to the same month in 2022, and credit to the government by 105%. The IMF does not publish inflation data on Argentina, but other institutions estimate it at 94.8%.[1]

It seems that Argentina is getting out of control. Putting it back in order would require a major operation. Giving credit to an economy in this condition would be risky for Brazil. It would be better not to sell on credit to this customer.

SOURCE: International Financial Statistics, International Monetary Fund.

The problem is that Brazil is Argentina’s biggest supplier. If Argentina stops importing from Brazil, Brazilian exports and production will decrease significantly. That explains Brazil’s interest in financing Argentina despite the latter’s dangerous situation. The two countries are trying to bypass Argentina’s increasing difficulty in getting dollars. But can they really bypass them?

The problem is that the Brazilian products that Brazil will export to Argentina will carry a substantial component of goods and services imported from other countries and paid in dollars. If trade is financed with reales, Brazil will have to continue importing these things but would have to pay for them with its dollar reserves, creating a monetary and financial problem for Brazil. This would not be sustainable.

The common currency

The other solution, a common currency, is even less sustainable. If Argentina does not reduce its excessive spending, how will it finance it? By issuing more of the new currency, causing more inflation, now in the two countries, and causing more devaluations, now to the common currency? Would Brazil allow this to happen? The scheme would blow up as soon as Brazil realises that Argentina would suck all its dollar reserves.


Thus, the lesson of this little story is elementary. The excessive production of pesos (or reales), which many think leads to larger outputs by creating more demand for production, actually leads to a fall in production in the medium-term. This is what is affecting these countries. It is not the shortage of dollars in the international markets, it is the excessive creation of pesos to finance government expenditure.

Given this fact of life, the risks of substantial reductions in the real output of these countries seem to be increasing—in Argentina because of yet another monetary crisis or an agreement with the IMF and in Brazil due to reduced exports to Argentina.



About the Author

Manuel Hinds
Manuel Hinds
Manuel Hinds has served as minister of the economy (in 1979) and of finance (in 1995-1999) in El Salvador, as division chief at the World Bank (in the 1980s and early 1990s), working with more than thirty countries, and as the Whitney H. Shepardson fellow at the Council on Foreign Relations in New York (in 2004-2005). He is the author of The Triumph of the Flexible Society: The Connectivity Revolution and Resistance to Change, Playing Monopoly with the Devil: Dollarization and Domestic Currencies in Developing Countries, and In Defense of Liberal Democracy: What We Need to Do to Heal a Divided America, and co-author of Money, Markets, and Sovereignty, with Benn Steil. He shared with him the 2010 Manhattan Institute´s Hayek Prize.
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