The new route: dollarization – The Argentine case

Introduction

Argentina has applied practically every single monetary system known by the economic theory, each monetary system was always followed by a dreadful crisis. The flexible exchange rate system led to a hyperinflation and the currency board led to a dramatic recession. Nonetheless, these periods of tribulations were not caused by the currency mechanisms per se, but by the unsound institutions that were in charge of the economic structure. Thus, dollarization represents an optimal policy, which would force the regime to be responsible with the money supply and at the same time this policy will provide economic stability. This paper will illustrate in an extensive manner the reasons why dollarization is the best route for Argentina.

A brief history of Argentina monetary procedures

The macroeconomic theories, specially the monetary and fiscal, that are addressed to maximize grow in the long term and minimize the output variations have became more complex during the last decade due to the financial crisis of this period. The reasons of this complexity have their origin in the unchanged monetary policy philosophy by the economic authorities, such as the Central Bank and the Finance Ministers. These authorities have been always focused on three main points: the acceptance of free circulation of capital (no restrictions to substitute national financial assets for international financial assets), the desire to maintain national macroeconomic policy and the desire to keep exchange rate stability. The crises of the second half of the 90"s, tequila effect, Asian crises, Russian and Brazilian have shown the incompatibility of such philosophy, especially in the developing countries. These crises have proven that is not viable to adapt autonomy monetary policies and at the same time maintain fixed exchange rates in a economy of free circulation of capitals. Moreover, once financial globalization is accepted as the most efficient way to attract investment projects and foreign savings, the only valid solutions are the extreme ones. These solutions are flexible exchange rate with autonomy in the monetary policy or fixed exchange rate without monetary autonomy. In Argentina, the macroeconomic policy makers have decided to renounce to the freedom of monetary policy and the flexible exchange rates for the following reasons:

• A high default risk (spread) applied to the interest rates, which discourage foreign investment

• The lack of credibility in the macroeconomic authorities

• A high inflation which discourage financial planning and reduced the acquisition power of the citizens

• The high costs to the nations wealth (GDP) as a result of external shocks, such as the Brazilian and Asian crises (lost of competitiveness and trading partners)

All of these costs have developed an authentic fear to float (Calvo and Reinhart 2000), which obviously led to the application of constitutional compromises to use firm exchange rate system (currency broad). However, we have seen that this mechanism did not bring the benefits that Argentina was expecting.

In this context, new proposals have been discussed about a possible solution for the Argentine crisis. One of these proposals that have caught significant attention is dollarization for Argentina as the new monetary system. Thus, this proposal has deployed several debates among economist and academics. On one hand, several analysts argued that Argentine regime already gave up to its monetary freedom and applied a fixed exchange rate system to bring financial stability to Argentina and it did not work. Therefore, a more radical currency system would not work either. Nevertheless, in spite that the currency broad and dollarization are very similar (at least in a first sight) the differences are quite significant.

The cost of the Seinoriage lost

In a more extensive analyses it would imperative to explore what would be the consequences for Argentina if it decides to dollarized. The main cost of dollarization that would be lost is seignorage. At present, Argentina earns perhaps 750 million pesos a year in seignorage. Since the size of Argentina"s economy, as measured by gross domestic product (GDP), is roughly 340 billion pesos, seignorage is only about 0.22 percent of annual GDP. In other low inflation countries, the seignorage can be as much as 1 percent. (Minisro de Economia Argentina) Argentina"s long history of inflation before the Convertibility Law has made Argentines less willing to hold local notes and coins than people in other countries with low inflation, so seignorage in Argentina is lower than average. Since the peso-dollar exchange rate is 1-to-1, there would be almost no one-time costs associated with converting computer programs and cash registers from pesos to dollars. In consequence, the administrative costs of dollarizing in Argentina would be very small.

Interest rates

The major benefit of dollarization would be, reduced interest rates in Argentina. With no peso-dollar exchange rate, currency risk would be eliminated, and the spread in interest rates between pesos and dollars for loans within Argentina would be closed. In January 1999, the interest rate for interbank loans in pesos was about 1 percentage point higher than the rate in dollars, and the spread was fluctuating around 5 percentage points for 1-year interbank loans. For non-bank borrowers, the spreads are higher. It is true that people who want to pay lower interest rates can borrow in dollars, but that exposes them to a currency risk that many do not wish to take, given Argentina"s long history of devaluations before the Convertibility Law.