The Argentine Currency Board pegged the Argentine peso to the U.S. dollar between 1991 and 2002 in an attempt to eliminate hyperinflation and stimulate economic growth. While it initially met with considerable success, the board's actions ultimately failed because of significant flaws in policy implementation. The Argentine peso (originally established as the nuevo peso argentino or peso convertible) is the currency of Argentina. ... ISO 4217 Code USD User(s) the United States, the British Indian Ocean Territory,[1] the British Virgin Islands, Cambodia, East Timor, Ecuador, El Salvador, the Marshall Islands, Micronesia, Palau, Panama, Turks and Caicos Islands, and the insular areas of the United States Inflation 2. ... 1991 (MCMXCI) was a common year starting on Tuesday of the Gregorian calendar. ... For album titles with the same name, see 2002 (album). ... Certain figures in this article use scientific notation for readability. ... World GDP/capita changed very little for most of human history before the industrial revolution. ...

Background

For almost twenty years, up to the end of the 1980s, Argentina experienced hyperinflation, poor or negative GDP growth, a severe lack of confidence in the national government and the Central Bank, and low levels of capital investment. After eight currency crises since the early 1970s, inflation peaked in 1989, reaching 3,000 % per annum. Per capita GDP was 10% lower than in 1980, social indicators deteriorated seriously, and the fiscal deficit reached 7.6% of GDP. Government After years of post-World War II instability, Argentina is today a fully functioning democracy. ... Capital has a number of related meanings in economics, finance and accounting. ... Invest redirects here. ... A budget deficit occurs when an entity (often a government) spends more money than it takes in. ...

To a large extent, the main reason behind this long period of hyperinflation was unsustainable growth of the money supply to finance the large fiscal deficits maintained by successive governments. Since Argentina could not participate meaningfully in world capital markets given the great investment risk it posed, the only course available was the financing of these fiscal deficits by monetizing them. This meant that the government levied an inflation tax to pay for the fiscal deficits, which in turn contributed to stalling growth. The examples and perspective in this article or section may not represent a worldwide view. ... An inflation tax is the economic disadvantage suffered by holders of cash and cash equivalents in one denomination of currency due to the effects of inflation, which acts as a hidden tax that subtracts value from assets. ...

Another reason for the instability of the Argentine currency was the fragility of domestic financial institutions. The Argentine banking crisis of 1980 underlined this point, as the Central Bank moved to confiscate the deposits of commercial banks to overcome a liquidity crunch. The examples and perspective in this article or section may not represent a worldwide view. ...

There were also external factors that further triggered the currency crisis, such as interest rate fluctuations. In the early 1980s, for example, the United States imposed tight monetary discipline upon its own institutions, which made it more expensive to borrow money because banks had fewer reserves. At other times, less restrictive monetary policy lowered interest rates in the developed economies, resulting in capital flows to developing countries, which produced real exchange rate appreciation, ballooning current account deficits, and, in many cases, full-blown currency crises. An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ... Monetary policy is the process by which the government, central bank, or monetary authority manages the money supply to achieve specific goals—such as constraining inflation or deflation, maintaining an exchange rate, achieving full employment or economic growth. ... It has been suggested that Underdevelopment be merged into this article or section. ... The term current account usually refers to the current account of the balance of payments (BOP) and contains the import and export items of goods and services. ...

The currency board

In July 1989, President Raúl Alfonsín resigned, and President elect Carlos Menem took office six months in advance. His early attempts to stabilize inflation failed, resulting in further depreciation of the peso and a serious reduction in the Central Bank's foreign currency reserves. Raúl Ricardo Alfonsín (born 13 March 1927) is an Argentine politician, who was the President of Argentina from 10 December 1983 to 9 July 1989. ... This article or section does not adequately cite its references or sources. ... Currency depreciation is the loss of value of a countrys currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system. ... The Argentine peso (originally established as the nuevo peso argentino or peso convertible) is the currency of Argentina. ... Foreign exchange reserves are the foreign currency deposits held by national banks of different nations. ...

In April 1991, Menem reverted the country's policies according to ideas of Washington Consensus to what was later to be called economic neo-liberalism. This system involved a program of massive privatization and labor deregulation laws, which encouraged foreign investment and infused the country with cash to finance its fiscal deficits. However, the linchpin of the new system was the introduction of the Convertibility System. The Washington Consensus is a phrase initially coined in 1987-88 by John Williamson to describe a relatively specific set of ten economic policy prescriptions that he considered to constitute a standard reform package promoted for crisis-wracked countries by Washington-based institutions such as the International Monetary Fund, World... This article does not adequately cite its references or sources. ... Deregulation is the process by which governments remove, reduce, or simplify restrictions on business and individuals in order to (in theory) encourage the efficient operation of markets. ... Convertibility is the quality of money which is officially backed by government reserves of a precious metal, probably the gold standard. ...

At the time, there was much debate in Argentina and abroad about how to control inflation and build confidence in local currencies in order to foster investment and growth. There were three options of exchange rate management available to any government: a floating exchange rate, a super-fixed exchange rate (including the possible use of a currency board), or a hybrid system. The hybrid system consisted of various levels of control over exchange rates, and it was discredited in the early 1990s when empirical evidence from several currency crises showed that, in a world of high capital mobility, a semi-fixed exchange rate was very unstable, because it allowed a country with poor monetary policy to exercise too much discretionary power. The consequence was that a government had to choose between either fixed or fully floating exchange rate systems. A floating exchange rate or a flexible exchange rate is a type of exchange rate regime wherein a currencys value is allowed to fluctuate according to the foreign exchange market. ... A fixed exchange rate, sometimes (less commonly) called a pegged exchange rate, is a type of exchange rate regime wherein a currencys value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold. ... // A currency board is a monetary authority which is required to maintain an exchange rate with a foreign currency. ...

Before the implementation of the currency board there was much debate over which currency or currencies to peg the peso against. In the view of many economists, the peso should have been pegged to a basket of currencies from the countries that were Argentina's major trading partners. Others argued that the peso should be pegged to the U.S. dollar because it would provide simplicity of understanding, the highest degree of safety, greater international credibility, and the promise of increased trade with the United States. The latter argument won the day, with both positive and negative consequences.

Argentina's currency board established a fixed pegging of one-to-one parity between the peso and the U.S. dollar. It also guaranteed full convertibility of pesos into U.S. dollars. The government hoped to establish local and international credibility in the peg and to limit the amount of local control over monetary and fiscal policy. The currency board regime intended to stabilize the peso, encourage both foreign and local investment, and foster sustained economic growth.

Bold text==Flaws in implementation== The main qualities of an orthodox currency board are:

• A currency board maintains absolute, unlimited convertibility between its notes and coins and the currency against which they are pegged, at a fixed rate of exchange, with no restrictions on current-account or capital-account transactions.

Caption1 Convertibility is the quality of money which is officially backed by government reserves of a precious metal, probably the gold standard. ... Image File history File links Example. ...

Caption2 Image File history File links Example. ...

• A currency board's foreign currency reserves must be sufficient to ensure that all holders of its notes and coins can convert them into the reserve currency (usually 110–115%).
• A currency board only earns profit from interest on reserves (less the expense of note-issuing), and does not engage in forward-exchange transactions.
• A currency board has no discretionary powers to effect monetary policy and does not lend to the government. Governments cannot print money, and can only tax or borrow to meet their spending commitments.
• A currency board does not act as a lender of last resort to commercial banks, and does not regulate reserve requirements.
• A currency board does not attempt to manipulate interest rates by establishing a discount rate like a central bank. The peg with the foreign currency tends to keep interest rates and inflation very closely aligned to those in the country against whose currency the peg is fixed.

The Argentine currency board violated all these rules at one time or another, except that of a fixed exchange rate. Full convertibility with the U.S. dollar became jeopardized upon implementation of exchange rate controls that provided a preferential exchange rate for exports. The currency board was allowed to hold up to one-third of its dollar-denominated reserves in the form of bonds issued by the government of Argentina. It acted as lender of last resort and regulated reserve requirements for commercial banks. And it engaged in monetary policy activities. The impact of all this was to reduce the credibility of the Argentine government's intent, and to put speculative pressure on the peso, despite the peg. A reserve currency (or anchor currency) is a currency which is held in significant quantities by many governments and institutions as part of their foreign exchange reserves. ... Profit, from Latin meaning to make progress, is defined in two different ways. ... A tax is a financial charge or other levy imposed on an individual or a legal entity by a state or a functional equivalent of a state (for example, tribes, secessionist movements or revolutionary movements). ... This article needs to be cleaned up to conform to a higher standard of quality. ... Reserve requirements, a tool of monetary policy, are computed as percentages of deposits that banks must hold as vault cash or on deposit at the central bank (in the United States in a Federal Reserve Bank), rather than, perhaps, lend out. ... An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ... Discount rate as used in finance and economics is distinct from the discount rate described below; please refer to discounting and discounts. ... In finance, a bond is a debt security, in which the issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity. ...

Results of the currency board

Argentina implemented its currency board in April 1991. Its main achievement was in controlling inflation, which was brought down from more than 3,000% in 1989 to 3.4% in 1994.

Another major accomplishment of the system was renewed economic growth. Enjoying the high world prices of primary products (Argentina's main exports), GDP grew at an annual rate of 8% between 1991 until the Tequila Effect of 1995. Even after the Mexican crisis, until 1998 the annual growth rate was 6%. The 1994 economic crisis in Mexico was an economic crisis that happened in December 1994 in Mexico. ... The 1994 economic crisis in Mexico, widely known as the Mexican peso crisis, was triggered by the sudden devaluation of the Mexican peso in the early days of the presidency of Ernesto Zedillo. ...

International trade also increased dramatically, reflecting the growing degree of openness of the country. Imports increased from US$ 11.6 billion in 1991 to US$ 32.3 billion in 2000. Likewise, exports also increased from US$ 12.1 billion in 1991 to US$ 30.7 billion in 2000. International trade is the exchange of goods and services across international boundaries or territories. ...

Despite these impressive results, there were also negative side effects on social issues, such as increased unemployment, unequal income distribution, increased poverty levels and decreased wage rates. Unemployment increased from 6.1% in 1991 to 15% in 2000 as the fixed exchange rate increased foreign price competition and forced local firms to invest in more advanced technologies that required less labor and higher productivity. An 1837 political cartoon about unemployment in the United States. ... A boy from an East Cipinang trash dump slum in Jakarta, Indonesia shows what he found. ... A wage is a compensation which workers receive in exchange for their labor. ...

Income distribution also showed no improvement — indeed it moved in the wrong direction: the bottom 20% of the population decreased its participation in national income from 4.6% in 1991 to 4.1% in 2000, while the top 20% of the population increased its share of income from 50.4% to 51.4%.

Initially, the poverty rate declined as hyperinflation receded (implying that the inflation tax was primarily absorbed by low-income households), but after the Mexican crisis the trend reversed. Although overall wages increased, they did not benefit all workers equally. Skilled and unskilled workers lost ground compared to managerial and professional income groups.

Government debt increased sharply. Unwilling or unable to raise taxes, and precluded from printing money by the currency board system, the government's only other recourse to finance its budget deficit was to issue debt instruments in the capital markets. Public debt increased sharply from 29.5% of GDP in 1993 to 50.3% in 1999. Moreover, this debt was in foreign currency, since the domestic private savings remained low, and it took place despite large inflows of income from the privatization of formerly state-owned companies. Associated with the increase in public debt was an increase in the debt service ratio, which increased from 22% of exports in 1993 to 35.2% in 1999, exacerbating an increasing current account deficit. The debt service coverage ratio, or debt service ratio, is the ratio of net operating income to debt payments on a piece of investment real estate. ... The term current account usually refers to the current account of the balance of payments (BOP) and contains the import and export items of goods and services. ...

Part of President Menem's program included large-scale privatization of state-owned companies. Unfortunately, because of the fixed exchange rate, privatization agreements generally linked price increase flexibility to the rate of U.S. inflation, which was often higher than that in Argentina. The relative prices of public utilities thus increased and shifted wealth from the state to the privatized firms — which, without any exchange control restraints, were free to expatriate these windfalls and invest them elsewhere.

External shocks also affected the Argentine currency board. The first was the Mexican crisis of 1994-1995, resulting in a liquidity crunch that drove interest rates sharply higher, stalling growth and spurring unemployment. In quick succession, the ensuing 1997 Asian and 1998 Russian financial crises pounded at the economy by further increasing interest rates as foreign investors became much warier of where they invested their assets, continuing to keep the cost of borrowing high for Argentina. The Brazilian crisis of 1999 probably had the most severe effect, because Brazil is Argentina's largest trading partner, and the crisis was coupled with an appreciating U.S. dollar and a slump in the world prices of primary products. Argentina's competitiveness in world markets was severely hit, given the peso's link to the appreciating U.S. dollar and weakening demand in its northern trading partner. As a result, the economy stalled and subsequently contracted. Market liquidity is a business or economics term that refers to the ability to quickly buy or sell a particular item without causing a significant movement in the price. ... The Asian financial crisis was a financial crisis that started in July 1997 in Thailand and affected currencies, stock markets, and other asset prices in several Asian countries, many considered East Asian Tigers. ...

These ongoing crises and the strong U.S. dollar in the late 1990s put the spotlight on the decision to peg the peso to the U.S. dollar rather than to a basket of currencies that were better aligned with its trade patterns. While Argentina was mostly trading with countries (Europe and Brazil) that did not have the U.S. dollar as their currency, the peso was fluctuating according to the U.S. dollar and not according to Argentina's actual economic position (this is known as the "third currency phenomenon"). Simply put, the dollar peg overvalued the peso in the rest of the world, especially against a weak euro and the Brazilian real, reducing Argentina's competitiveness and compounding the account deficit. World map showing the location of Europe. ... For other uses, see Euro (disambiguation) or EUR (disambiguation). ... ISO 4217 Code BRL User(s) Brazil Inflation 3. ...

Abandonment of the peg

During the second half of 2001, the pressure mounted on the currency board but there was no clear way out. Since most of country's debt was denominated in U.S. dollars, there would be a huge cost to breaking the peg, not to mention the long-term damage to Argentina's credibility in world capital markets. On the other hand, allowing the market to determine the exchange rate would radically improve competitiveness and eliminate the current account deficit along with the need to borrow money to finance it. Many solutions were considered, including changing the peg to a currency basket of U.S. dollars and euros (which would have entailed an effective and controlled devaluation of the peso), and dollarization (using U.S. dollars as the country's only currency). Devaluation is a reduction in the value of a currency with respect to other monetary units. ...

In December 2001, Argentina suspended payments on its external debt and restricted bank deposit withdrawals. In January 2002, it repealed the Convertibility Law and adopted a new, provisional fixed exchange rate of 1.4 pesos to the dollar (a 29% devaluation); soon afterward it completely abandoned its peg and allowed the peso to float freely, resulting in a swift depreciation of the peso, which lost 75% of its value with respect to the U.S. dollar in a matter of months. Currency depreciation is the loss of value of a countrys currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system. ...

Sources

• Baer, Werner; Elosegui, Pedro & Gallo, Andrés. (2002) The Achievemnets and Failures of Argentina's Neo-Liberal Economic Policies, Oxford Development Studies, Vol. 30, No. 1, pp. 63-85.
• Bird, Graham. (2002) Argentina's Currency Board: Cry for Argentina - But not for its currency board, New Economy: Surrey Centre for International Economic Studies, pp. 158-165.
• Cavallo, Domingo F. & Cottani, Joaquin A. (1997) Argentina's Convertibility Plan and the IMF, AEA Papers and Proceedings, May, Vol. 87, No. 2, pp. 17-22.
• Dornbusch, Rudi. (2001) Exchange Rates and the Choice of Monetary-Policy Regimes: Fewer Monies, Better Monies, AEA Papers and Proceedings, May, Volume 91, No. 2, pp. 238-242.
• Edwards, Sebastian. (2002) The Great Exchange Rate Debate after Argentina, The North American Journal of Economics and Finance, Volume 13, Issue 3, pp. 237-252.
• Gurtner, Francois J. (2003) Currency Boards and Debt Traps: Evidence from Argentina and Relevance for Estonia, (Oxford, Blackwell Publishing Ltd.), pp. 209-228.
• Hanke, Steve H. (2002) On Dollarization and Currency Boards: Error and Deception, Policy Reform, Vol 5 (4), pp. 203-222.
• Hanke, Steve H. (2003) The Argentine Straw Man: A response to Currency Board Critics, Cato Journal, Spring/Summer, Vol. 23, No. 1, p. 47-57.
• Horn, Gustav A., Fritsche, Ulrich. (2002) Argentina in Crisis, DIW Economic Bulletin, Vol. 39, No. 4, pp. 119-126.

Schuler, Kurt. (2002) Fixing Argentina, Policy Analysis, July 16, No. 445.

External links

• The Crisis that Was Not Prevented: Lessons for Argentina, the IMF, and Globalisation, Jan Joost Teunissen and Age Akkerman (eds.), Fondad, 2003, book, pdf)

See also

• Argentina
• Economy of Argentina
• Argentine economic crisis (1999-2002)
• Digital gold currency