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Latin America’s Currency: Stuck Between a Rock and a Hard Place

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Written by Oscar Montealegre, Contributor

Whether or not the U.S. is actively pursuing a weak dollar policy can be debated forever, however the reality is such that the consequences of a weak dollar can stimulate the exports and trade, thus reducing unemployment and creating new jobs. However, not everybody is jumping for joy with the advent of a weak dollar reality. Because economics today operates in a global arena, the depreciation of the U.S. dollar usually means an appreciation of a basket of certain currencies.

In Latin America, this is exactly what has been occurring since the financial crisis of 2007-2009. Just in the past 12 months, Colombia’s currency has gained 25 percent versus the dollar, Uruguay’s 19 percent, Brazil’s 24 percent, Peru’s 10 percent, and Chile’s 12 percent.

These countries were accustomed to having a weak currency compared to the dollar. Now, the exporting sector of Latin American countries has had difficulties adjusting to a stronger currency because products are no longer cheap and competitive in the international market.

The reason currencies in Latin America are rising is basic economics. Currently, interest rates in the U.S. are basically at zero percent, therefore investors are pouring money in other currencies that have higher interest rates (i.e. Brazil and Peru) and then later converting the gains back into U.S. dollars. To make matters worse for Latin American countries, the U.S. appears to have no desire to increase their interest rates in order to stimulate and encourage economic activity. As a result, exports such as basic commodities will be more expensive for Latin American companies. Appreciation of currency strikes the economy where it hurts the most, it increases costs such as labor and logistics. The attractiveness of having low costs and high profit margins no longer exists. Gone are the days of buying low and selling high for Latin America.

The end of this new phenomenon is nowhere in sight. Just recently, Morgan Stanley’s economists announced that they forecast Latin American currencies to continue to appreciate. On top of that, they forecast that the economies of Latin America will grow more than the U.S. Simple translation: Latin America will continue being a hotspot for investors, and with their bond yields currently being higher than the U.S., more foreign investment is expected. Ultimately, constant increase of foreign capital will result into rapid currency appreciation.

It would have been preferable for Latin America that currencies would increase at a gradual pace; governments would perhaps be better equipped to confront this threat. For example, in 2009 Brazil’s stock market had an 84 percent gain coupled with the Brazilian real appreciating 34 percent. These are rapid expansions that give indications of growing bubbles, and if not handled appropriately, they could become detrimental in the long term for Brazil—just take a look at Japan’s current problems.

When fostering a strong currency it makes it more difficult to export your goods and products. This is the reason why China has been stubborn to concede to U.S.’ wishes of allowing the remninbi (Chinese Yuan) to float freely against other currencies—for fear of the remninbi strengthening. China’s economy is largely dependent on exports, and it has achieved this success with its cheap labor, a weak currency, and competitive prices. Many Latin American countries apply the same strategy. They rely strongly on their exports, but the difference between China and Latin America (excluding Venezuela and Argentina) is that Latin American countries do not manipulate nor peg their currencies, or artificially undervalue their currencies.

Latin American countries are not used to having a strong currency. This is a whole new territory that they are crossing. Countries like Colombia are having a difficult time adapting to this new reality. Colombian flower, coffee and textile exporters are voicing their concerns that their profit margins have been dramatically cut because of the rising Colombian peso; in addition, maintaining their global competitiveness is now more of a challenge. Chile too has raised concerns. Earlier this month, the Chilean peso hit its’ new high compared to the dollar since 2008, due to the rising price of their main export, copper.

It would be prudent for Latin American governments and businesses to accept this new normal. The sooner they do, the better Latin Americans can cope with this new normal of having a strong currency. It is no secret that everything comes at a cost; currency appreciation has been the cost for Latin America’s recent economic success.