Argentina’s de facto Dollarization

11 June 2012


Last week it was reported that Cristina Fernández de Kirchner would convert her savings from dollars to pesos, and urged her ministers to do likewise in order to provide an example and to give a concrete demonstration of faith in the Argentinian currency — and, by extension, the economy of Argentina (cf. Argentina’s President Fernandez stops saving in dollars). Then the Financial Times published Dollar curbs squeeze Argentine economy by Jude Webber in Buenos Aires. What’s going on with Argentina and dollars?

What’s going on is an illustration of Gresham’s law, commonly stated as “bad money drives out good money” (and also known as the “Copernicus-Gresham Law” because it was earlier formulated by Copernicus). While one often thinks of “bad” money as debased coinage, in cases of de facto currency pluralism, when more than one form of legal tender is employed in economic transactions, the distinct forms of currency might individually gain a reputation as “good” or “bad.” Argentine pesos are losing their value at an official inflation rate of almost 10 percent, but at an unofficial rate that may be several times higher. As a result, Argentina has been experiencing substantial capital flight as people look for safe places to put their money. In response to capital flight, the government has attempted to crack down with regulations on buying dollars.

The limitations placed on dollars is having an effect in the wider economy because, as the FT article cited above explains, real estate prices in Argentina are denominated in dollars. In other words, with big ticket items you have to come up with dollars because people don’t trust pesos when a lot of money is on the line. The FT article said, “Consequently the property market is paralysed, with a knock-on effect on construction.”

Another way to express the denomination of real estate transactions in dollars would be to say that the real estate market in Argentina has been dollarized — a de facto dollarization, to be sure, but still a dollarization. And with a substantial portion of the economy dollarized, but with the greater part of the economy still denominated in pesos, Argentina has de facto currency pluralism.

At present the situation is a mildly tense standoff between a people and its government; the people are trying to secure as much of their savings as they can, while the government is trying to clamp down on strategies of securing savings that exports them from the country or transforms them into dollars. Maybe it would be better to call this a cat-and-mouse game than a standoff. But the worry here is that a tipping point will be reached and instead of a slow-motion sequestering of good money, there will be a sudden loss of confidence that generates a run on the banks. People in Argentina know what it is like to go to the bank and not be able to withdraw their money, so they are with drawing it now and either sending it abroad or buying something with it that is relatively immune to inflation, financial panic, and economic collapse.

As I have said in many posts in the past, this kind of situation is potentially devastating to the middle class. The poor have no savings and live from day to day; the rich already have most of their money invested elsewhere in the world in financial instruments not directly connected to their country of origin. It is the middle class that has a little bit of money in the bank — saved for a home, saved to start a business, saved for an education, or what have you — that suddenly becomes unavailable in the financial panic, and in the aftermath of the panic may be devalued to some tiny portion of its former value. Again, it is the middle class who do not have the connections or the knowledge or the financial savvy and expertise to shelter their modest savings that are most at risk. And they know it.

Argentina’s economy is large, and therefore diverse and robust, but the level of mismanagement that is the case at present leaves one wondering how long the game of musical chairs can go one before the music stops. The recent re-nationalization of YPF is only a symbol of a much more pervasive government intervention in markets that is not serving the people of Argentina (though the move to re-nationalize YPF was widely popular — I have my Twitter account set to tell me what is “trending” in Argentina, and in the wake of the re-nationalization there were several trending topics related to YPF, all of them favorable to the re-nationalization). The economy is now hemmed in by restrictions and regulations that are choking off trade.

Argentina is turning its back on globalization both by regulations that are hampering international trade and by essentially opting out of global financial markets by failing to address the long term structural issues that led to its default. The FT article cited above quoted Martín Redrado (former governor of the Argentine central bank who was tossed out by Cristina Fernández) as follows:

“Argentina is not part of the international financial community so cannot access international credit markets and does not have [large] portfolio flows or investment flows. The trade surplus, which is decreasing, is the only source of dollars.”

It sounds a bit strange to say it, but what we have here is Juche South American style — an attempt to be economically self-sufficient which sounds good rhetorically but runs counter to everything we know about economics. Trade benefits everyone involved. That’s why people trade. If they did not see it in their interest to trade, they would not trade. The Argentine government is painting itself into a corner where its only remaining economic strategy is to keep ratcheting up the same regulations that are choking the life out of the economy.

Of course, there is always the possibility of reversing that strategy and deconstructing the artificial barriers to trade that choke economic growth, but when a government is politically and ideologically tied to a particular strategic economic policy, reversing that policy can create a lack of political confidence that is parallel to the lack of economic confidence that causes bank runs.

The de facto dollarization of some sectors of the Argentine economy puts definite limits on the extent to which the government can ratchet up further restrictions on the use of dollars, but as long as dollars are in use, the “good” dollars will be hoarded while the “bad” pesos will be used in exchange, in line with Gresham’s law. At the same time, a flourishing black market in dollars required for certain transactions (like real estate), with dollars trading at a premium well above the official exchange rate, fosters a sense of cynicism and a contempt for rule of law. When institutions force individuals into crime and dishonesty simply in order to go about the daily business of life (like buying a house), it is difficult to have any really genuine faith in these institutions.

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Grand Strategy Annex

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