For the weaker economies of the eurozone, adopting the euro is comparable to
the earlier unhappy dollarization experiment by Argentina, which should have
served as a cautionary tale to all national economies linked to the European
currency.
Commenting at the onset of the sovereign debt crisis in Greece, Argentine
President Cristina Fernandez characterized International Monetary Fund (IMF)
"conditionalities" imposed on
Greece as being "unfortunately condemned to failure". She spoke from
experience, as Argentina was hit by one of the world's biggest sovereign debt
defaults in 2001, from which the once prosperous nation still has not fully
recovered from IMF "assistance".
Argentina is blessed with a rich economy by nature in terms of natural
resources and by policy in terms of productivity from the high education level
of its population. There is no compelling reason why Argentina should become an
economic basket case with regard to its sovereign finance, except for falling
under the malicious spell of neo-liberalism.
Beginning after World War II, Argentina institutionalized a
rightist-corporatist welfare state where job-linked social insurance was a
policy anchor and social assistance programs were the norm. In the corporatist
welfare state, a large population in the so-called informal sector was left out
of the corporatist welfare system. A populist movement supported by trade
unions and an economic model of import-substituting industrialization were the
socio-economic-political background for the formation of this corporatist
welfare state.
During the 1990s, with the influence of US economists, neo-liberal elements
were added to the Argentine welfare state under the liberalization carried out
by the Carlos Menem Peronist government. Still, social insurance and pro-labor
policy survived sweeping financial liberation. Key elements of the corporatist
welfare state regime continued. The neo-liberal government attempted to carry
out more drastic social security and labor reforms, but was unable to do so due
to popular support of the political legacy of corporatist welfare of the
Peronist era.
In April 1991, Argentina under Menem adopted the neo-liberal programs of the
Washington Consensus, which involved wholesale privatization of the public
sector, deregulation of financial markets and capital decontrol to attract
foreign investment and credit with the aim to infuse the country with easy cash
to finance its resultant recurring fiscal deficits. Significantly, it
introduced interest rate liberalization and removed all controls on
cross-border capital and credit flow.
The centerpiece of the new neo-liberal regime was the Convertibility Law of
1991, making the Argentine peso fully convertible and pegged to the US dollar
at parity. Argentina then employed a parallel dual currencies system in which
the peso and the dollar both circulated legally in Argentina and traded at
parity maintained by a currency board regime administered by the central bank.
Currency board monetary regime
A currency board is a monetary regime under which the monetary authority
commits to maintaining a fixed exchange rate of its currency pegged to a
stronger foreign currency such as the dollar as an anchor, by holding adequate
reserve of the anchored currency. It is a rule-based monetary system that
requires changes in the monetary base to be matched by corresponding changes in
foreign reserves in a specified foreign currency at a fixed exchange rate.
The monetary base is defined, at the minimum, as the sum of the currency in
circulation (banknotes and coins) and the balance of the banking system held
with the central bank (the reserve balance or the clearing balance). The
monetary rule often takes the operational form of an undertaking by the
currency board to convert on demand domestic currency into the reserve foreign
currency at the fixed exchange rate.
The classical currency board regime evolved in colonies under British
colonialism in mid-19th century to peg the local currency of the colonies to
the pound sterling. In theory, it relied on three anchors to fix the exchange
rate. The first anchor was strict monetary and fiscal discipline backed fully
by pound sterling reserves. The second anchor was free currency flow with
liberalized interest rates within the British Empire. And the third was full
currency convertibility within the British Empire. The currency board was an
imperialistic monetary structure to allow the British Crown to control monetary
policy in the whole empire. In practice, not all three anchors were
operationally maintained in all currency board regimes.
The models of currency board adopted by Argentina (1991), Estonia (1992), and
Lithuania (1994), with deposit reserves as liquidity buffers, was an operative
choice only for a strong economy with very large foreign reserves, for which
ironically none of the three above countries qualified. Pegging a local
currency to the US dollar for the purposes of promoting foreign trade and
finance requires voluntary submission to dollar hegemony and surrendering
monetary sovereignty.
A currency peg to the dollar allows the home economy to gain entrance to the
huge US consumer and capital markets while minimizing currency exchange rate
risks. At the same time, it requires strict monetary and fiscal discipline that
puts stress on a weak local economy.
Convertibility and financial attacks
Still, even for a strong economy with large foreign reserves, the cost of
defending the fixed exchange rate from speculative or manipulative market
attacks could be huge, if speculators should perceive the fixed exchange rate
as out of line with a rapidly changing external market environment or even
internal contradictions. Manipulators can then design attack strategies to
drain wealth form economies bent on defending their currency pegs, as they did
in the UK in 1992 and Hong Kong in 1998.
For example, in the 1970s, the Bank of England played a key role during
recurring bank crises of stagflation in the UK, and again in the 1980s when
monetary policy again became a central part of British government policy. The
Bank of England did not become a central bank until May 1997, when the
government gave it responsibility for setting interest rates to meet the
government's stated inflation target.
This was almost a decade after the Big Bang, the term given to the financial
deregulation on October 27, 1989, of the London-based security market. The Big
Bang was comparable to May Day in 1975 in the United States, which ushered in
an era of discount brokerage and diversification into a wide range of financial
services using computer technology and advanced communication systems, marking
a major step toward a single world financial market.
The Exchange Rate Mechanism (ERM) was a fixed-exchange-rate regime established
by the then European Community designed to keep the member countries' exchange
rates within specific bands in relation to one another. The purpose of the ERM
was to stabilize exchange rates, control inflation rates (through the link with
the strong and stable deutschmark) and nurture intra-Europe trade. It was also
designed to enhance European participation in world trade in competition with
the US, creating the equivalent of a "United States of Europe" in the form of a
European Union (EU) and as a stepping stone to a single-currency regime - the
euro.
Britain joined the ERM in October 1990 at a fixed central parity of 2.95
deutschmarks to the pound, an over-valued rate intended to put pressure upon
the British economy to reduce inflation rather than institutionalizing
international competitiveness. British pride might have played a role in
insisting on a strong pound. This chosen rate, or any fixed rate required by
ERM membership, proved misguided because it tried to benefit from the effect of
a single currency for separate economies without the reality of a single
currency within an integrated economy.
During the 23 months of ERM membership, from October 1990 to September 1992,
Britain suffered its worst recession in six decades, with the gross domestic
product (GDP) shrinking by 3.86%. Unemployment rose by 1.2 million to 2.85
million. The total price to the United Kingdom Treasury for maintaining of ERM
fixed exchange rate of the pound sterling had been estimated to be as high as
13.3% of 1992 GDP. The number of residential mortgages with negative equity
tripled, reaching a peak of 1.25 million, and company insolvencies rose above
25,000 a year.
The British Conservative government of John Major sought to balance political
and macroeconomic considerations, only to fail in its effort to "support the
unsupportable" to prevent a devaluation of a freely traded pound by market
forces. If the UK had not lost some ฃ8.2 billion defending the pound's
unsustainable exchange rate, it could have avoided budget deficits, tax hikes,
cuts in public spending, and the unpopular value-added tax on fuel. Spending on
the National Health Service could have been more than doubled for 12 months.
Withdrawing from the ERM released the British economy from persistent deflation
and provided the foundation for the non-inflationary growth subsequently
experienced. It enabled monetary policy to be freed from the sole task of
maintaining the exchange rate, thus contributing to economic expansion by a
combination of rational monetary measures.
While ERM countries were compelled to maintain relatively high real interest
rates to prevent their currencies from falling outside the permitted bands,
Britain outside of the ERM enjoyed the freedom to benefit from lower rates.
Hong Kong faced the same problems from the 1997 Asian financial crisis and will
not be liberated from recurring global economic crises until its currency peg
to the US dollar is lifted. For a small open economy, waiting for an improved
economy before de-pegging its currency is like waiting for death to cure an
infection.
For a currency that is fully convertible, the appropriate exchange rate at any
particular time is that which enables its economies to combine full employment
of productive resources, including labor, with a simultaneous
balance-of-payment equilibrium. An excessively high exchange rate causes trade
deficits and domestic unemployment, while a low one generates an excessive
buildup of foreign-currency reserves and stimulates domestic inflationary
pressures that lead to a bubble economy. The rule does not apply to China,
which does not have a fully convertible currency.
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
