Currency wars: the truth about South America's oil economies

The South American economies, largely united under the Mercosur trading bloc, have been fuelled by China’s vast appetite for commodities since the early 2000s. However, as Asian economies suffer a slowdown and commodities prices fall, South American currencies have taken a hit. Here’s why these countries are battling it out on the foreign exchange market:

Collapsing commodity prices

Since 2011, oil prices have fallen from $112 to $48 per barrel. This has hurt the trade balances of economies like Venezuela, where oil revenues account for about 95% of export earnings. Additionally, China’s growth slowdown and recent stock market plunge has led to a collapse in its demand for commodities, of which South America is a major exporter.

Stocks such as iron ore have since fallen from $126 dollars to $46 per metric ton, while copper is now valued at $2.2 per pound – down from $3.5. Profit margins have also been affected by increased production costs, further impacting the sustainability of export-led economies like Brazil, Colombia and Argentina. 

Currency impact

During the commodity boom years, investors looked to South America to escape the recession affecting the US and Europe. This gave the region a decade of relative prosperity, reducing both poverty and debt levels. However, these economies failed to diversify and become more competitive during this time. This has made it highly dependent on the commodities market and as such, more sensitive to its volatility now.

In an effort to maintain its competitive advantage and offset the impact of falling commodity prices, many South American economies have devalued their currencies. Since then, Colombia’s free-floating peso and the Brazilian real have depreciated about 30%, while the Argentine peso has lost around 40% of its value.

The problem could intensify if the US Federal Reserve decides to increase interest rates in the future. This is significant to South America because a large proportion of its loans and trade are denominated in US dollars. Should the Fed raise interest rates, South American currencies could depreciate even more, risking further price hikes on consumer goods.

In addition to inflationary risks, South America is faced with the prospect of competitive devaluation. In order to stimulate trade and exports, central banks may take measures to devalue their currencies. The pressure to keep on doing so – in order to regain competitive advantage – will adversely impact trade in the region in the long term.

Policy differences

More complex differences are also fracturing the Mercosur bloc. For example, Venezuela’s strict price controls and pegged currency means it’s significantly overvalued at current rates. Colombia's peso falls in line with oil prices due to its free-floating nature, while Ecuador trades with the US dollar. This disparity makes it harder for authorities to determine an accurate exchange rate and leads to major capital losses or gains.

The relatively unstable nature of these currencies could lead to higher fees or hidden costs when it comes to international money transferIf you’re looking to send money to or from South America, find the best rates from a range of trusted brokers with The Money Cloud’s free comparison tool.

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Martin Ham

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