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The Argentine Straw Man: A Response to Currency Board Critics

It is noticeable, on the one hand, that a large part of the best work on Money is topical. It has been prompted by particular episodes, by particular experiences of the writer's own time. --Sir John Hicks (1967: 156) Sir John certainly would have agreed that particular experiences prompt faulty work on Money, as well. Argentina's recent crisis is a case in point. It has spawned a deluge of commentary on alternative exchange rate regimes. The majority of this writing (aimed at both an academic and lay readership) contains elementary analytical and factual errors. (1) The most oft-repeated and egregious errors are the following: * Argentina employed a currency board from April 1, 1991, until January 6, 2002, that rendered the central bank, the Banco Central de la Republica Argentina (BCRA), incapable of employing a domestic monetary policy. * The peso's one-to-one exchange rate with the U.S. dollar was overvalued and made Argentine exports uncompetitive in world markets. * The inflexible currency board and overvalued peso caused the Argentine crisis. A three-part reform consisting of a peso devaluation, "pesofication" of the economy, and a freely floating exchange rate would reinvigorate the economy. * Replacing the peso with the U.S. dollar--"dollarization"--was and is an infeasible alternative. The Currency Board Misnomer To put an end to hyperinflation, Argentina inaugurated something like a currency board system on April 1, 1991, by rechartering the BCRA. Argentines called the system "convertibility." Convertibility maintained a fixed exchange rate between the peso and its anchor currency, the U.S. dollar, on the spot market. That nominal anchor checked inflation: the consumer price index at the end of 2001 was about where it was in 1994. (2) The BCRA's charter allowed it to behave more like a central bank than a currency board in many important respects. (3) A currency board maintains a floor and a ceiling of 100 percent and 110 percent, respectively, for the foreign reserve cover of its monetary liabilities. Its net domestic assets are zero or frozen. Thus, a currency board cannot sterilize foreign currency inflows, offset outflows, or use discretionary monetary policy. The convertibility system had a floor under the BCRA's foreign reserve cover, but no ceiling, and the BCRA's net domestic assets were not frozen. Hence, the BCRA could sterilize inflows of foreign currency and offset outflows. The BCRA used the central banking powers in its charter liberally. Indeed, in virtually every month of the convertibility system's existence, the BCRA sterilized or offset changes in its foreign reserves, and in most months after 1994, it did so aggressively. During the system's life span, there was, on average, a negative correlation between changes in net foreign and domestic assets on the BCRA's balance sheet, with 59 percent of the changes in net foreign assets being either sterilized or offset with changes in the BCRA's net domestic assets (Hanke 2002a: 210). The offsetting was especially dramatic in 2001. Foreign reserves fell by $12 billion over the course of the year. This decline was offset 122 percent by increases in the central bank's net domestic assets. The above evidence demonstrates that, contrary to the musings of most observers, the BCRA under convertibility maintained considerable discretion, especially after 1994. In that period, the BCRA's net domestic asset position was more than six times more volatile than that of Chile's central bank, which clearly has an independent monetary policy and has had a floating exchange rate since 1999. Under convertibility, the BCRA retained additional central banking powers, offering lender-of-last-resort facilities, adjusting reserve requirements, and regulating the banking sector. Over the lifetime of the system, the BCRA issued 1,588 new regulations via its Series A circulars--a truly staggering rate of intervention in the banking system. …