It has been Argentina's miracle cure for inflation, the source of its
financial stability for the last eight years. But the country's currency
board may have outlived its usefulness. Investors are now wondering whether
it's time to get rid of the board, which uses ample reserves to keep the
peso at parity with the U.S. dollar--but which deprives authorities of other
monetary tools, such as printing money or devaluing. Even President Carlos
Menem has looked into replacing the peso with the greenback as Argentina's
national currency. The debate got hotter in late May, when uber-financier
George Soros rattled the stock market by saying that the peso was
overvalued.
Although most Argentines favor keeping the board, there's a strong argument
for a more flexible approach. The danger is that whatever happens to the
currency, Argentina will avoid the tougher task of liberalizing its economy.
Without economic reform, any new currency reform will prove futile.
TWO OPTIONS. Argentines fear the peso's dollar peg is deepening their
recession by making its products uncompetitive--at home and abroad. Indeed,
if interest rates in the U.S. go up, Argentina's do, too--just what a
recession-wracked economy doesn't need. The economy could shrink 2.5% this
year. To ward off speculators eager to test the currency board's resolve,
the government will probably have to cut the budget or increase taxes to
cover its expected $6 billion fiscal deficit.
Should Argentina drop the board, its options are two. It can simply remove
the peso from circulation and dollarize. The attraction of this approach is
that speculators will have nothing to attack. The other alternative is to
float the peso and let it drop. A cheaper peso would make Argentine products
competitive again--and give the economy a shot in the arm.
If the government were to make a move, it would surely prefer to dollarize.
The Menem government is already using the idea to discourage investors from
fleeing now. If Argentines and foreigners believe dollarization is more
likely than a messy peso devaluation, they are less likely to pull out of
the market or withdraw bank deposits. In late May, Deputy Economy Minister
Pablo Guidotti asserted that Argentina could adopt the dollar unilaterally
if it saw a speculative threat.
Yet neither option presents an ideal solution. The peso already equals a
dollar, so switching to greenbacks wouldn't make Argentina more competitive.
With a dollarized system, Argentina would still lose ground when a trading
partner such as Brazil devalues. U.S. officials have already told Buenos
Aires that it would have no say in Federal Reserve Board or Treasury Dept.
decisions. Some analysts, including former Economy Minister Domingo Cavallo,
even say the dollar isn't the most appropriate currency to adopt, since
Argentina trades more with Europe than with the U.S. Cavallo favors a common
currency with Brazil.
CREDIBILITY GAP. A floating peso would present its own problems. Argentines
fear that without the dollar as anchor, years of hard-earned stability would
be thrown away, and an all-too-familiar run of hyperinflation would loom.
Argentina could also attempt a managed-currency approach, by which the peso
would be devalued gradually. But that would lack credibility, since the
central bank has not actively handled exchange-rate policy since 1991.
Argentina's political situation also makes some investors uneasy. Menem will
leave office in December after 10 years. Leading presidential contenders
have pledged to maintain the status quo. But signs of political instability
could trigger enough capital flight to crater the peso--and the board.
It's a risky situation. But Argentines will ratchet up the risk unless they
tie currency reform to other, admittedly painful measures. No matter what
path they choose, no currency overhaul will succeed until Buenos Aires
begins to ease the heavy tax and regulatory burden on business and control
government spending. An overhaul of the country's rigid labor and tax laws
would help Argentine companies compete--and lend a solid foundation to
whatever currency system the country finally chooses.
By Ian Katz
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