Myths and Lessons of the Argentine “Currency Crisis” by Joseph Salerno

Joseph Salerno wrote an outstanding article about the economic turmoil in Argentina. Unlike the sloppy reporting of the mainstream financial press, Salerno carefully defines terms to arrive at the crux of Argentina’s problems:

Money creation, in conjunction with a pegged exchange rate, is therefore the one and only cause of a so-called “currency crisis.”

Salerno makes four main points in the article.

  1. First, the sharp decline in the value of the peso does not represent the onset of a so-called “currency crisis” but rather the very means of resolving a crisis already long underway. For the “devaluation” of the peso by the Argentine monetary authorities refers to nothing more than the removal of price controls that have maintained the price of the U.S. dollar in terms of the peso below the market equilibrium price and thereby generated a permanent excess demand for dollars in Argentina. In other words, the devaluation is simply the admission that the peso had already been robbed of a significant part of its value by inflation. This had been concealed by the fact that at the controlled price of dollars, prices of foreign imports were artificially low in terms of pesos while Argentine exports were rendered more expensive and less competitive in foreign markets. The Argentine government tried to suppress the resulting trade deficit and shortage of dollars by exchange controls, that is, by measures designed to ration out the available dollars to its cronies. In addition, people increased their demand for dollars to hoard or invest abroad because they anticipated the inevitable “devaluation” of the peso and consequent loss of purchasing power in terms of goods.
  2. Second, many media commentators and even economists insist that the devaluation does indeed precipitate a domestic crisis because it generates a broad rise in peso prices of both imported goods and exportable domestic products, which are now sold abroad in greater quantities, reducing the supplies available for domestic buyers. This general increase in prices therefore injures Argentine consumers, they claim. But this response leaves out the unseen and beneficent consequences of the removal of any price control. It is obviously true that, for example, the abolition of rent controls reduces the welfare of existing renters who must pony up higher rents and benefits apartment owners. But it is also true that there are many others who benefit, including all those renters who were shut out of the market because of the apartment shortage even though they were willing to pay higher rents or who succeeded in leasing apartments for much higher black-market rents. Likewise the abolition of a price control that overvalues the peso benefits Argentine export firms and their workers and suppliers as well as those consumers who were precluded from importing goods or making foreign investments that they desired or who were only able to do so by paying a much higher price for dollars on the black market.Thus the adjustment of Argentine prices in accord with the true market value of the peso does not make the entire nation poorer. It simply redistributes real income from those who were benefiting from the distortion of the price system by rate pegging and exchange controls, namely, government employees, favored firms, and organized labor, to those without political connections who were victimized by the intervention. In addition, in the case of both rent controls and the pegging of the exchange rate, the abolition of controls results in greater efficiency in resource allocation and the maximizing of the volume of mutually beneficial exchanges at the equilibrium price.
  3. Third, the media focus on the hemorrhaging of foreign reserves by the Argentine central bank as a main factor precipitating the crisis is ridiculous. For it is not the loss of reserves but the very fact that the central bank needs to hold dollar reserves at all that is a sign of crisis. The only reason that the central bank needs reserves is to prop up the overvalued peso by selling dollars in short supply and buying up the inevitable excess of pesos. If the dollar-peso exchange rate were left free to be determined solely by market forces the Argentine monetary authorities would not find it necessary to hold even a single dollar, precisely because the supply and demand for each currency in terms of the other would balance at every moment without surplus or shortage. If the Argentine government needed to make purchases abroad or to make payments on its foreign debts it could easily acquire the dollars to do so by purchasing them from commercial banks or other private institutions on the foreign exchange market. It would pay for whatever dollars it required with pesos that it received in tax revenues or borrowed from the public or ordered printed up by the central bank. In the disorderly world of national fiat currencies, a nation avoids additional chaos and crises by permitting the market to determine the value of its currency in terms of other fiat currencies with differing rates of inflation.
  4. This brings me to my fourth point. Many politicians and other observers on the right in Argentina and elsewhere attribute the crisis to the profligate spending programs of the leftist Fernández de Kirchner government. They argue that the social subsidies, nationalization of foreign-owned firms, expansion of the regulatory state, etc., have driven the government budget into deficit. But government budget deficits are not the cause of the overvaluation of a currency and the shortage of foreign exchange any more than they are the cause of inflation. Thus, if the additional spending had been financed by raising taxes or borrowing from the public, Argentine prices would not have risen. However, the Argentine government decided to finance these deficits by rapidly expanding the money supply, at an average rate of 30 percent per annum over the last four years. This resulted in a rapid inflation of Argentine prices that unofficially reached 28 percent last year, more than twice the 11 percent reported by the Argentine government. Inflation and its anticipation stimulates imports and the flight of capital abroad and suppresses exports.

The entire article can be read here.

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