Currency Board Critics Cite Selective Facts

This article was published in the Canadian publication, National Post, June 7, 2000

Paul Krugman doesn't care much for hard-money types or countries that employ hard-money monetary regimes. Argentina is one of his favorite targets because it has operated with a currency board-like system for nearly a decade. Under that set-up, the Argentine peso is fully backed by U.S. dollar reserves and trades freely at a fixed 1-to-1 rate with the greenback. The fact that Argentina is in a temporary slump provides Prof. Krugman and like-minded folks plenty of grist for their mills. Fine. But readers should beware. There is a lot of grist that is missing in action.

For example, the currency board critics love to invoke John Maynard Keynesto assist in making their case. As they tell it, Keynes always favouredcentral banks and discretionary monetary policy as a means to avert businesscycles. While digging through the British Foreign Office archives, KurtSchuler and I discovered that this assertion is simply untrue. When troopsfrom Britain and other Allied nations invaded north Russia in the waningdays of World War I, they found a chaotic local currency environment. TheRussian civil war had begun, and every party to the conflict was issuing itsown near-worthless local currency. There were more than 2,000 separateissuers of fiat rubles. Trade was difficult because few people would acceptfiat rubles in exchange for goods and services.

To facilitate trade with the local population in north Russia, the Britishestablished a National Emission Caisse for the area in 1918. The Caisseissued "British ruble" notes, backed by British pounds sterling andconvertible into pounds at a fixed rate. As we document in our book, RussianCurrency and Finance (1993), this currency board was the handiwork of noneother than John Maynard Keynes.

So much for Keynes. What's missing from the Argentine story? Perspective!Carlos Menem was first elected president of Argentina in 1989 and completedhis second term in 1999. Shortly after I first met Mr. Menem in late 1989,and with encouragement from Congressman Jose Maria Ibarbia, Kurt Schuler andI began work on a comprehensive blueprint to stabilize Argentina's currency.The plan, Banco central o caja de Conversion?, was completed in 1990 andeventually was published in Buenos Aires in 1991. It provided the road mapfor Argentina's currency board-like system, which was installed on April 1,1991.

And how did the Argentine economy fare during the Menem decade? As Table 1shows, Argentina responded with a growth spurt that left its neighbours inthe dust. All this is not an anomaly. Since 1950, countries with currencyboards have realized average GDP growth per capita that is 54% higher thancomparable countries that had central banks with discretionary monetarypowers.

This is not to say that a sound currency is everything. Indeed, Argentinadesperately needs a good dose of supply-side economics. Unemployment is highbecause labour market regulations are burdensome and taxes are too high andcomplex. Bring on deregulation and a flat tax. Clone Hong Kong, please. Andthat's not all. The government apparatus needs a complete overhaul. The onlyway to attack the endemic corruption spawned by the state is to shrink it.Those reforms, on top of its sound money, would put Argentina back on ahigh-growth track.

How well do currency boards do in a crisis? The most interesting recent bigcrisis was the Asian fiasco. With the collapse of the Thai baht in mid-1997,the entire region entered an economic maelstrom. Excepting Hong Kong, whichhas a currency board, all the other countries in Southeast Asia have centralbanks that employ discretionary monetary policies. Those central bankingcountries allowed their currencies to float. And as Table 2 shows, floatthey did. Downward.

Consequently, their economies took heavy hits. There's no denying that theworse the devaluation, the worse the economic devastation. Indonesiasuffered the most. Some said the poor, at least, were insulated from theproblem. Hardly. Local price run-ups hurt the poor the most.

As the storm in Asia raged, Hong Kong was able to mitigate the damage betterthan its neighbours did. Moreover, Hong Kong has come roaring back with muchmore vigor than its neighbours. Indeed, during the first quarter of 2000,its real GDP rose by a whopping 14.3% over the previous year.

All these facts have not gone unnoticed by the cognoscenti in Washington.They have become friendly to the currency board idea and its close cousin,"dollarization." Unfortunately, the central banking pundits continue to plytheir wares with lots of information missing in action.

Table 1
In U.S. dollars, 1989-1999
Country Change in GDP
per capita
Argentina 230.3%
Uruguay 135.3%
Chile 114.3%
Bolivia 41.1%
Paraguay 36.6%
Brazil 7.7%
Source: Steve H. Hanke

Table 2
In U.S. dollars, 1996-1999
Country Exchange Rate Change in GDP
v. U.S. dollar per capita
Hong Kong -0.5% -5.6%
South Korea -26.0% -18.4%
Thailand -31.6% -30.8%
Malaysia -33.5% -28.6%
Indonesia -66.4% -35.5%
Source: Steve H. Hanke

Steve H. Hanke

Steve H. Hanke is a a Cato Institute adjunct scholar, professor of applied economics at The Johns Hopkins University in Baltimore, and president of Toronto Trust Argentina in Buenos Aires. He served as an advisor to the Menem government in 1995-96.