Letter to the Editor: A Deadly Combination for Argentina

This article originally appeared in The Financial Times on January 29, 2003.

Sir, Martin Wolf claims that Argentina employed a currency board (“Why debt is such a burden to Latin American countries”, January 22). This is a misnomer.

Under a currency board, a floor of 100 per cent and a ceiling of no more than 115 per cent are typically mandated for the foreign reserve cover of a board’s monetary liabilities. Furthermore, if a board’s balance sheet contains net domestic assets, they are frozen. Accordingly, a currency board has no latitude to sterilise foreign currency inflows or offset outflows and cannot engage in discretionary monetary policies.

Argentina’s central bank operated what was called a convertibility system from April 1991 through 2001. It had a floor under the foreign reserve cover, but no ceiling. Moreover, the central bank’s net domestic assets were not frozen. Argentina’s central bank used the discretionary powers granted under convertibility liberally. Indeed, in virtually every month of convertibility’s existence, the central bank either sterilised or offset changes in its foreign reserves, and in most months after 1994, it did so aggressively. In the post-1994 period, the net domestic asset position of Argentina’s central bank, operating under a pegged exchange-rate regime, was over six times more volatile than that of Chile’s central bank, which was operating under a floating exchange-rate regime.

What proved deadly in Argentina - as Kurt Schuler and I warned as early as 1991 - was a central bank that combined a hyperactive monetary policy with a pegged exchange rate. On that score, the crisis in Argentina had exactly the same hallmarks as the Asian, Russian and Brazilian crises noted by Mr Wolf.

Steve H. Hanke is a professor of applied economics at the Johns Hopkins University in Baltimore. He served as a senior economist on president Reagan’s council of economic advisors.