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'Dollarization' Debated for Argentina - 2001-08-21

Western governments and the International Monetary Fund are facing a dilemma in deciding whether to provide new financial assistance for Argentina, a country that over the past decade has abandoned traditional reliance on big government solutions to economic problems. The IMF wants to be responsive to the needs of a member country without softening its usual loan conditions.

It was only eight months ago that the IMF organized a $40 billion loan package for Argentina. Most of that money is gone and Argentina now wants more.

Several influential economists believe Argentina's latest crisis is largely of its own making. They say Argentina made a fatal error by holding on to its one-to-one currency peg with the dollar, at a time when the dollar was steadily gaining value against other currencies. The dollar peg gave a competitive export advantage to countries like Brazil which have a currency that floats against the dollar. Weakening exports slowed economic activity in Argentina, which is now in its third year of recession.

Morris Goldstein is a senior economist at Washington's Institute for International Economics. He says it was an overvalued exchange rate and an excessive foreign debt that got Argentina into its current crisis. Mr. Goldstein says the IMF should provide only modest and highly conditional new loans.

"What I'm saying is that they should provide limited financing, but only on the condition that Argentina agrees to both restructure its debt and abandon its convertibility system in favor of a floating exchange rate," he said. "By doing that I think they would have at least a fighting chance for success. But just giving them money and leaving the debt situation as it is and not touching the currency regime, I think, is just throwing the money away."

Another economist, Steve Hanke of Johns Hopkins University, is convinced that Argentina will neither devalue its currency nor default on its $128 billion debt. Mr. Hanke helped set up Argentina's dollar peg currency system 10 years ago. Given the rapidity with which Argentines are now converting pesos into dollars, Mr. Hanke believes Argentina should abandon the peso entirely in favor of the U.S. dollar, a process known as "dollarization." "There's really no point anymore in having an official peso. It gives you more headaches than anything else. So why not officially dollarize and truncate this tortuous process of voluntary dollarization that's going on anyway," he said.

Mr. Hanke says full dollarization would bring down interest rates and revive the weak economy.

Morris Goldstein disagrees. "Dollarization really, I think, is not the answer for them," he argued. "They need to go to a floating exchange rate like Brazil with inflation targeting. And they need to do something on the debt."

Domingo Cavallo, who put in place the dollar peg in 1991, recently returned to government to take charge of economic policy. Economist Hanke, who was advising the Argentine government at the time, says his former ally worsened the country's crisis, in June this year, by both tampering with the exchange rate mechanism and saying he would eventually shift the peg from the dollar to the euro.

"Those two changes spooked the market," explained Mr. Hanke. "Because the market's interpretation was, well, here he goes on the slippery slope towards exiting convertibility completely and devaluing the peso. And that's when Argentina went from a financial crisis into a panic. So the panic phase that they're in now is really a product of Cavallo. Things were much better pre-Cavallo than they are post-Cavallo."

Mr. Cavallo is holding firm to the strategy of no devaluation, no default, and no deficit spending. Traders in the world's financial markets think otherwise. They believe the debt will be forcibly restructured and that Argentina will not obtain enough new money from the IMF to maintain the one to one dollar peg.