CASE 2.2 TROUBLE IN MERCOSUR ince its inception, Mercosur had become Latin USS37

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CASE 2.2 TROUBLE IN MERCOSUR ince its inception, Mercosur had become Latin USS374 billion) From 1991 to 1998, trade betwee America's most successful integration agree Beazil and Argentina increased 500 percent to $1 ment. Among its members were Latin America'sbillien. However, in 1999, Mercosur trade volum largest economy, Brazil (GDP USS1,085 billion) fell 20 percent. Argentina and Brazil were bot and its third-largest economy, Argentina (GDP experiencing recessions and disagreed on whic Chanter 2 The Global Economy 47 foreign exchange policy to follow. This disagree alowing the peso to Boat freely like the real would be Ekely to erode conhidence even more, resulting to the US. dollar and banned the printing of unbacked Nonetheless, costs of doing business in Brazil ment threatened the future of Mercosur. sConvertibility Flan pegged its peso in a devaluation of the peso. currency. By restricting its money supply and curbing were soon 30 percent below those in spending, Argentina reduced inlation Argentina saw its trade surplus with Brazil disap 5,000 percent in 1989 to 1 percent by the year pear. The placing of quotas on certain products im- 2000. Through the early and mid-1990s, Argentina ported from Brazil, the irst quotas in Mercosur experienced an economic boom attributed to its trade history, had alarmed Brazil, which was investigat liberalization, monetary and foreign exchange stabil inglegalmeans to have them lifted. Many Argentine ity, and the privatization of previously state-owned companies and multinational corporations, such as Philips Electronics NV and Goodyear Tire and Similarly, Brazil's Real Plan initially pegged he Rabber Company, had shifted production fronm Brazilian real to the U.S. dollar, InBation fell from Argentina to Brazil Argentina claimed to have lost 2,500 percent in 1993 to 2.5 percent in 1998. Trade 250,000 jobs since the devaluation in Beazil. Unem- marched with signs saying "Made in of Buenos Aires and investment iberalization encouraged invest ment in Brazil, but pent-up demand for capital and consumer goods caused the country's merchan dise balance to drop from a surplus of USS10.5b ion in 1994 to a delicit of US$63 billion in 1998. to steal the furniture wockers summed up the anti-Brazilian feeling: The Beazi- lns ane Eke bad neighbors that come into our house The Asian financial crisis in mid-1997 caused forIn December 2001, the Argentine govenment eign investors to wory about the future of other tempoarly set limits on the amount of money developing countries. Foreign capital Bed Bazh that Argentines could withdraw from banks or and the country's BOP deteriorated. A subsequent tansfer abroad. In the previous year, 20 percent of recession, augmented by the failure of the Beazlinnk deposits in the country had been converted by Congress to pass key spending reforms, further thir owners into dollars and moved to overseas eroded investor confidence in the country. Brazil's accounts. Banks were concemed about how long foreign exchange reserves continued to dwindle. dollar reserves would last in the country at the The govemment responded by announcing a ate of one peso to one dollar. Rumors of a possible change to the free Boat of the real The real plum devalaation of the peso were nfe by early 2002. But meted against the dollar and consequently plum devaluation remained peoblematic. Many debts and contracts in Argentina were denominated in dollars. meted against the Argentine peso. Seill, the Argentine govemment remained com A devaluation of the peso would increase the cost Argentina in pesos of meeting those dollar obligations. This penen remained com- mitted to foreign exchange with the US. Treasury the situation in tum could cause a banking crisis dollarizing its economy. was feasible. Panama had adopted ce Discussion Quesions US dollar as its currency in 1904Already over half of the bank deposits and loans in Argentina were in dollars. Automated teler machines dis pensed both pesos and dollars. The U.S. Federal Re 2 Which foreign sxchange regime would you prefer to serve shipped tons of dollar-denominated bis see in Argentina fyou were a US exporter of heavy machinery? A European exporter of cosmetics? A every year. Nearly two-thirds of the al S. currency circulated outside most $500 billion in U. the United States Nonetheless, dollarization would be practicaly ineversible. Argentina would give up contol over David Wesel and Caig Tomes, "Tassing the BuckWal its money supply to the US. Federal ReservEaal January 18,1999, PAl,Cmnd Mam Mob Critics argued that the US. Federal Reserve set pol, "Ne holashing. Wal Sneh l, May 2, 2000, p. Ali cy to assist the U.S. economy, which had little inUS Deartment of Sat, FY 2000 Counary Comemencial Guides common with the Argentine economy. Even talking about dollarization would undermine conidence in the peso. Others noted that the altemadive of A and Baek and Michele Walin, *Analy warn That a Fase loasing Feso ls Only Part of the Fux That Argentina Needs

Explanation / Answer

Answer 2.

Case 1- Being a US exporter of heavy machinery, the dollar regime would be quite good, If Argentina opts for the dollarization. Because it will lead to the uniformity in the payment and smoothness in the process.

Case 2- Being a EU exporter of cosmetics, I think because of the stability of euro and the devaluation of peso, the free floating exchange rate would be a better option.

Case 3- Being a Brazilian exporter of automobiles, since the Brazilian real has fallen as compared to peso in the past, but the production costs in Brazil are way less, so I would definitely recommend the fixed exchange rate between Brazilian and Argentine currencies. Being neighbors, it would be easy to do business if exchange rates aren't floating amd are kind of fixed in a way.

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