last updated -- August 2000

"No" to Dollarization -- The End of an Interesting Experiment

On the weekend before an IMF delegation paid a visit to the new administration on Tuesday, 30May00, Carlos Menem, still the titular head of the Peronist Party, gave a news conference which was captured with the headline "Dollarize or Devalue." Menem was not advocating devaluation, of course, but he was arguing publicly that problems with the current economic situation (e.g., increasing demonstrations and work stoppages by organized labor with (May 2000) 14% unemployment) was sufficently serious that Argentina may be led to eventual devaluation if they don't dollarize soon. The de la Rua administration, along with US Treasury secretary Lawrence Sumners, took a position against dollarization. Their denials to the contrary, Menem and his first Economics Minister, Domingo Cavallo, selected the unitary exchange rate for the currency board in order to promote currency substitution. Since it was installed in April 1991, over 60% of bank deposits and 75% of internal debt contracts have been contracted in dollars as of Y2000. The unwillingness to carry the grand Menem/Cavallo experiment to its logical conclusion is the first obvious/major economic departure of the new de la Rua administration.

If Menem is correct, the days of the currency board are numbered. The new Economics Minister, Jose Machinea, argued that Argentines should be "free to choose" between currencies. This position may conclude an interesting chapter in the evolution of monetary institutions. It's not that the decision against dollarization was a wrong decision for the welfare of Argentines, but it is a prophetic decision in the evolution of money.


Dollarization by the Market Rather Than by Policy?

In a 1999 Business Week interview, the president of Argentina's Fundacion Capital, Martin Redrado, made the interesting argument that Argentina's currency board

is a dual monetary system, not a fixed exchange rate. The Central Bank has $25 billion of liquid reserves, exactly the same as the $25 billion of circulating money plus cash deposits. So if there is a run on the currency, what will happen is that the economy will be dollarized, [emphasis added] and convertibility allows for that.
Redrado's argument that convertibility allows anyone to switch from pesos to dollars, whether hand-to-hand-currency or bank deposits is unassailable. So, the logic continues, if there is a run from the peso to the dollar, banks (central as well as commercial) will accomodate the substitution of one currency for the other. And, indeed, if one compares the composition of currencies before and after the Tequila crisis, there was a significant movement from Argentine pesos to USD. But something else happened during the Tequila crisis -- something not in Redrado's story -- total   (dollar as well as peso) bank deposits fell almost 20%. The speculative attack on Argentina in the spring of '95 involved more than a flight from the peso to dollars. And it's this "something else" that causes authorities to worry that it could happen again. As Roberto Frenkel (6/99) has argued, the "Argentine version of the currency board is far from dissipating the risk of default."

Laboratory experiments are rare in social science but Argentina's currency board has provided the world with an institutional setting that conveniently separates a currency-crisis from a debt-crisis. A simple explanation of why money, whether denominated in pesos or dollars, was withdrawn from banks is that depositors worried, just as they worry in any run on banks, about the quality of loans on the books of the banks. The Tequila crisis was much more than a currency crisis -- it was a debt crisis. Once the Tequila crisis made it unambiguously clear that there is a problem of indebtedness, then the IMF/G7 approach of solving debt problems with more debt becomes problematic.


Back to the Y2000 Argentine projection page.