Should South American Central Banks Rethink Dollar Reserves?

Posted on 04/17/2023

The U.S. holds tremendous geopolitical power in South America. This echoes back to the Monroe Doctrine. The Monroe Doctrine is a United States foreign policy position that opposes European colonialism in the Western Hemisphere. It holds that any intervention in the political affairs of the Americas by foreign powers is a potentially hostile act against the United States. Many Latin American countries rely on the U.S. dollar to give their currencies a level of stability. In fact, countries in Latin America are among the most dollarized in the world. The ratio of foreign currency deposits to total bank deposits helps show the spread of dollarization in the country. Furthermore, sovereign debt issuances in U.S. dollars put pressure on these countries. At the same time, over the past two decades, China has dipped its hand into the finances of South America. The sino giant leverages its trade advantages to promote the use of its currency with major commerce partners. China is pushing for yuan settlements in trade and investment, aiming to displace the U.S. dollar as a financial intermediary. In this current world, the Federal Reserve is still the world’s central bank. The euro which is the second largest reserve currency, overseen by the European Central Bank, had to tap swap lines with the Federal Reserve at times to obtain the U.S. dollars needed to stabilize its financial system.

A number of smaller South American countries rely on the U.S. dollar. There are factors are impacting these Latin American countries. The first factor is a U.S. dollar shortage. In Bolivia, the U.S. dollar has become scarce in the black market. Many Bolivians are withdrawing their U.S. dollar deposits or rushing to buy the U.S. currency amid increased concern about Bolivia’s economic fragility. Bolivians have lined up at the central bank or have been waiting online to buy U.S. dollars at the official exchange rate. Bolivia’s Leftist President Luis Arce, who was economy minister from 2006 to 2017 during Bolivia’s period of bonanza, has tried to calm the markets. Luis Arce has insisted there will be no change to Bolivia’s managed exchange rate system in which the Central Bank has intervened to keep the local currency’s value stable to the U.S. dollar over the past 12 years. Bolivians remember what happened in the 1980s with the bolivianos. These experiences are mimicked in countries like Venezuela and Argentina, where rapid inflation has eroded purchasing power for the local people. The U.S. dollar shortage began in Bolivia early in 2023. This is at the time the U.S. Federal Reserve continued to raise interest rates to battle inflation at home. Bolivian Finance Minister Marcelo Montenegro told the media the central bank is rebuilding its international reserves as it deals with a “transitory” liquidity problem affecting the country. The minister declined to elaborate on what the current level of reserves is.

Leftist Brazilian President Lula da Silva Partners with China
The second factor lies in geopolitics. Brazilian President Lula da Silva, a veteran leftist, who emerged from jail to oust Jair Bolsonaro to become leader of Brazil met with Chinese leaders in April 2023. Lula took office in January in 2023. Dilma Rousseff, the former Brazilian President was named head of the New Development Bank in Shanghai on April 13, 2023. Brazil’s new government is seeking stronger ties with China and other countries. China and Brazil have recently announced a deal to trade in their own currencies, dropping the U.S. dollar as an intermediary. Brazilian President Lula da Silva also criticized the International Monetary Fund (IMF), accusing it of ‘asphyxiating’ the economy of certain countries.

“Why should every country have to be tied to the dollar for trade?… Who decided the dollar would be the (world’s) currency?” Brazilian President Lula da Silva said in Shanghai on April 13, 2023.

“Why can’t a bank like the BRICS bank have a currency to finance trade between Brazil and China, between Brazil and other BRICS countries?… Today, countries have to chase after dollars to export, when they could be exporting in their own currencies.”

Lula critiqued the IMF on its role with Argentina.

“No bank should be asphyxiating countries’ economies the way the IMF is doing now with Argentina, or the way they did with Brazil for a long time and every third-world country,” he said. “No leader can work with a knife to their throat because (their country) owes money.”

Under the currency deal announced in March 2023, Brazil and China have named two banks – one in each country – to conduct their massive trade and financial transactions by directly exchanging yuan for reais and vice versa, instead of going through the U.S. dollar. China has similar deals with Russia, Pakistan, and several other countries.

The move for Latin American countries to dedollarize can be accomplished by a number of ways that include relying on other foreign currencies from other trading partners like the yuan and/or having the citizenry have confidence in holding the national currency which is linked to the improved confidence that comes with the elimination of high inflation and the implementation of sounder economic and financial policies.

Keywords: Banco Central de Bolivia (Central Bank of Bolivia).

Get News, People, and Transactions, Delivered to Your Inbox