The only viable alternative is to dollarize. Dollarization means that the dollar would become the sole legal tender of the realm. Panama, Ecuador and El Salvador are already dollarized. Every Argentine peso would be converted to dollars, perhaps at the current one-to-one rate. Then again, Economy Minister Domingo Cavallo might use the opportunity to engineer a quickie devaluation, setting the conversion rate at 1.25 (or higher).
Critics of dollarization maintain that Argentina’s existing fast tie to the strong dollar decked the economy. The dollar began gaining strength against Europe and Asia in April 1995, rising about 40 percent against Europe and 30 percent against the yen. In 1998 neighboring Brazil floated its currency, the real, which has since been cut in half against the dollar, dealing a further blow to Argentina’s competitive standing as an exporter. But Argentina’s Achilles’ heel was not a strong peso. It was government spending greatly outpacing revenue collection, creating the need for chronic new borrowing.
Meanwhile, the International Monetary Fund played the role of an enabler by treating periodic cash-flow droughts with billions of dollars in rescue packages. Argentina could have gotten better economic advice from Mr. Micawber, one of Charles Dickens’s characters, who advised young David Copperfield, “If a man had twenty pounds a-year for his income, and spent nineteen pounds nineteen shillings and sixpence, he would be happy, but that if he spent twenty pounds one he would be miserable.”
Argentina would benefit from dollarization in many ways. Handcuffs would be placed on the central bank so it could not engineer a Latin American-style hyperinflation by printing money. All currency risk would disappear. That would bode well for the future course of interest rates. A presumed third advantage would be an end to the ridiculous practice of provincial governments’ issuing their own currency.
Going against this is the total forfeiture of control over monetary policy. Argentina is well warned that Federal Reserve chairman Alan Greenspan’s concerns end at U.S. borders. But a central question is whether the Federal Reserve can avoid having to take responsibility for Latin American bank supervision. Like it or not, crises of any sort in the dollarized zone would adversely affect the value of the dollar.
In theory, dollarization could catch on further. If Argentina takes the step, other Central and Latin American countries might follow, though it is hoped not as deathbed converts. Still, crisis–not political consensus, as was the case with the euro–will be the likely mother of a dollarized hemisphere.
