Johns Hopkins economist Steve Hanke has been producing a ton of valuable research over at the Cato Institute, particularly in the realm of currencies and monetary stability, and a recent RT interview with him has caught my attention. Those seeking insights regarding Argentina’s monetary history and the functioning of orthodox currency boards would do well to watch this one.
In April of 1991, Argentina’s elected officials initiated a convertible-currency system which, as Hanke explains, had all the appearances of a currency board: the cloning or matching of a foreign currency, to give stability and credibility to the domestic currency, the Argentinean peso. Indeed, many people simply thought that Argentina had a currency board.
However, those in control violated one of the key elements of a currency board, the 100-percent-or-greater backing of currency releases with foreign denominated assets. There were domestic assets on the balance sheet, Hanke explains, and these were volatile — more volatile than the assets of the Chilean central bank. Thus, the Argentineans made a mockery of the purported goals of the exchange system.
In the early 1990s, Hanke wrote about the inevitable failure of this approach, and sure enough, that came to be in 2001. Argentina fell from grace spectacularly, and those in power continued the nation’s cycle of crises that Carlos Sabino wrote about for the PanAm Post earlier this year.
The process is well-known, and it repeats itself with disturbing consistency: prices start to increase; people lose trust in the local currency and seek shelter in the US dollar; governments impose price and exchange controls; and unemployment rises.
Hanke’s insights and the lack of confidence in the peso becomes more relevant now, because Argentina is entering a similar crisis. There are already constraints on access to foreign currency and a spread of around one third between the official and unofficial (blue dollar) exchange rates. Further, the official inflation rate of around 11 percent is comfortably under the actual 16 percent rate, as calculated by the Troubled Currencies Project.
At this point, dollarization looks to be the best bet for Argentina, as Ecuador has had now successfully for more than a decade, if not bitcoin or a private currency. A local currency — with an attempt at a currency board or not — is just too vulnerable to temptation for government spending via monetary expansion (the inflation tax).