ECONOMYNEXT – Mainstream inflationists both within and without Argentina have bashed a dollarization plan put forward by a right wing candidate, in a shocking parallel to the monetary ignorance displayed in Sri Lanka about currency boards.
Argentina, a country that fell into the so-called ‘first world’ bracket in the lines of USA and Canada, by World War I, started to decline after a sterilizing central bank, Banco Central de la República Argentina was set up in the inter-war years, allowing economic bureaucrats to engage in ‘macro-economic’ policy, denying monetary stability to the people.
Argentina started to suffer severe monetary instability and then never ending defaults from around 10 years after the break-up of the Bretton Woods. Almost every two US tightening cycles were followed by severe currency crises and defaults.
Sri Lanka closed the economy when the Bretton Woods collapsed the currency started to collapse from the 1980s discrediting an economic liberalization plan implemented by then President J R Jayewardene barely two years after it was started.
Sri Lanka escaped default as it was not a heavy commercial borrower until about a decade ago.
Argentina however has been in commercial markets for more than a century before the collapse of the Bretton Woods severely undermined monetary standards and gave more flexibility to macro-economists to destroy currencies, analysts say.
Presidential candidate Javier Milei has proposed official dollarization, which will completely stop the ability of macro-economists to destabilize the country through yet another peso collapse.
In the year to September 31, the latest Argentina peso (state economists had struck 13 zeros of the peso earlier) has collapsed from 147.67 to the US dollar to 349.6 inflating 136 percent, while official inflation for the 12 months to September was 138 percent.
Curb rates are said to be around 800 to 1000.
The way econometrics measure ‘depreciation’, the number never goes above 100 percent.
Monetary Fog
Many Argentinians however already own dollar assets and the country is partway into market dollarization.
“Not surprising is the fact that Milei’s political opponents, whether Peronist or on the center-right, and their mouthpieces in Argentina are opposed to dollarization,” write US economist Steve Hanke and Emilio Ocampo from the University of CEMA in Argentina in the National Review.
“What is somewhat surprising is that a string of foreign economists and so-called financial experts have weighed in and fanned the flames of anti-dollarization propaganda. To name just a few of the notables: Robin Brooks, Arminio Fraga, Guillermo Ortiz, Mark Sobel, Alejandro Werner, and Iván Werning.
“Some have even argued that a debt default, not dollarization, is the solution to Argentina’s problems.
“And, to top it all off, dozens of Argentine economists have signed a letter slamming dollarization as a “mirage.”
Countries with chronic monetary instability must necessarily have a policy making elite that believe in printing money for growth or blindly targeting the policy rate aggressively on some other excuse, analysts say.
There is a surprising lack of knowledge both about note issue banking in general and their own and global monetary history involving either free banking or other market-based regimes that bring economic stability or the knowledge to operate a fixed exchange rate.
READ MORE on how dollarization takes place after legal tender laws are relaxed or ignored: The Economist Gets It Wrong on Dollarization in Argentina
History Repeats
Argentina’s brouhaha “is reminiscent of 1981 and U.K. Prime Minister Margaret Thatcher’s showdown with the British Keynesian establishment a— a showdown that the Iron Lady won handily,” write Hanke and Ocampo.
Spending was cut, value added taxes were hiked to cut the deficit but income tax slabs were lowered in a bid to shift tax from income to consumption giving freedom for ordinary people to make economic decisions and collect taxes after transactions had taken place.
Thatcher’s policies were condemned by 364 leading economists.
In a letter to the Times newspaper, they wrote a knee‐jerk Keynesian response: “Present policies will deepen the depression, erode the industrial base of our economy and threaten its social and political stability,” Hanke and Ocampo recall.
“What is missing from the dollarization critics’ polemics is any grasp of basic economic principles, common sense, other countries’ experiences with dollarization, and an understanding of Argentina’s history and its current predicament,” they write.
“The first fact that needs to be understood is that the Argentine people have already chosen the dollar as their preferred currency.
“Argentines have more than US$200 billion in greenback bills stashed away in safe-deposit boxes at banks or at home “under the mattress.”
“In comparison, the supply of pesos, measured by M3, is worth less than US$50 billion. Nobody in Argentina wants to hold pesos. While Argentina might not be officially dollarized, it remains the most heavily dollarized country outside of the U.S.
Similar reactions were seen in Sri Lanka when a currency board arrangement was proposed by analysts and classical economists after seeing the inflationist policy direction the country was taking particularly after the end of a 30-year civil war.
“In Ecuador, they were able to [dollarize] in just nine months,” Milei told the publication El Pais on July 25.
“In El Salvador, they let people do it freely – this process was done in 24 months. And is it easy. Super easy. I’m not to blame for the intellectual limitations of the economists from Juntos por el Cambio (opposition).
Market dollarization also took place in Cambodia, which started to attract export oriented FDI despite being run by a former Khmer Rouge fighter who staged a coup.
How monetary stability is denied
In Argentina, the BCRA engineers a currency collapse like clockwork by failing to roll-over its own securities (Leliqs and NOBACs) in a bid to maintain a fixed policy rate and extend a credit cycle beyond the US, and later by intervening and sterilizing outflows as forex shortages emerge.
Both practices inject money and encourage private sector credit without deposits, regardless of what the budget deficit is.
The currency, a so-called flexible exchange rate or soft-peg with less tight exchange controls than in Sri Lanka, collapses steeply about a year after injections begin, often sending inflation to triple digits.
Sri Lanka’s inflationists engineer currency collapses by inflating money supply by:
a) failing to roll-over government securities at market rates as private credit picks up from the previous crisis,
b) active liquidity injections through overnight, term open market operations to suppress rates, and
c) outright purchase of government securities to mis-target the longer-term yield curve, critics have said.
In the third quarter of 2018 in a remarkable move:
d) the currency was slammed by liquidity injected against government dollar deposits instead of domestic assets as usually happens in flexible inflation targeting/soft peg regimes.
Without knowledge of sound money or the operation of note-issue banks and with denial of monetary stability as the foundation of the policy framework through flexible inflation targeting and peer regimes, Sri Lanka has no way to grow steadily, critics have said.
A new monetary law in 2023 has legalized printing money for growth – targeting potential output – an idea first put forward by John Law and triggered the first IMF programs in Sri Lanka in the 1960s via central bank re-financed rural and other private credit.
Hanke proposed a currency board for Argentina in the 1980s, but the BCRA and its sterilization powers remained in the ‘convertibility’ arrangement that followed.
Outside economists and the media dubbed it a currency board, though Hanke warned in a Wall Street Journal op-ed that the currency would collapse as the basic ingredient of unsterilized interventions was lacking and that it was still a soft-peg.
The BCRA’s new operating rules have a loophole that “is big enough to drive a truck through” Hanke wrote in October 1991, shortly after analyzing the published convertibility law, especially in the pro-stability politician who wanted to control the central bank, Domingo Cavallo, left office.
In the event the peg lasted around two Fed cycles. (Colombo/Oct23/2023)
