Time for Argentina to ditch the peso and dollarize
“It’s Time to Ditch the Argentine Peso”
By Steve H. Hanke, courtesy of Fundacion Bases
In addition to facing an acute COVID-19 crisis , Argentina’s troubled economy is collapsing, and, as often happens, the tightening knot of inflation is suffocating Argentines. The official inflation in Argentina for August 2020 is 40.70% for the year. And, like never before, Argentina’s official inflation rate is relatively close to the rate I calculate each day using high-frequency data and the purchasing power parity theory., a methodology that has long proven its validity when compared to official statistics. Today, I measure Argentina’s annual inflation rate and it stands at 37 percent, but probably not for long —the knot of inflation is generally followed by a door that does not open.
As Milton Friedman put it in his 1987 contribution to the New Palgrave Dictionary of Economics on the “quantity theory of money” (QTM), “The conclusion (of the QTM) is that substantial changes in prices or nominal income are almost always the result of changes in the nominal supply of money”. The income form of the QTM states that: MV = Py, where “M” is the money supply, “V” is the velocity of money, “P” is the price level, and “y” is the real GDP (national income).
Let’s use the QTM to do some base calculations to determine what the “gold growth” rate is for the money supply . This is the growth rate of broad money that would allow the Central Bank of the Argentine Republic (BCRA) to achieve its inflation target. I calculate the “gold growth” rate for the last decade.
According to my calculations, the average annual GDP growth over the last decade is 1.38 percent, the average annual growth of the Total Money Supply (M3) is 32.47 percent, and the annual change average speed of money is 0.87 percent. Using these values and the BCRA’s inflation target of 11 percent (the average of the BCRA’s inflation targets between 2010-2020), I calculated that the annual “gold growth” rate for Argentina’s Total Money Supply was of 11.51 percent.
Gold growth rate = 11% + 1.38% – (0.87%) = 11.51%
The “gold growth” rate is represented in the graph below. Annual growth rates in the total money supply over the past decade are also included, as well as the average, which is 32.47 percent. It is clear that the BCRA has been well above the “gold growth” rate during the last decade. Currently, annual growth in the money supply is sky high at 53.71 percent — more than 40 percentage points above the “gold growth” rate.
With money growing at more than 50 percent a year, it should come as no surprise that Argentines treat pesos like hot potatoes – they try to exchange them for US dollars as fast as they can. In the traditionally Argentine style, the BCRA decided on September 15 to further restrict Argentine access to US dollars in the foreign exchange rate market by keeping the limit on purchases of dollars for savings at $ 200 per month, while increasing the taxes citizens pay on purchases of dollars to pay off credit card debt or for savings to an impressive 35 percent.
Instead of limiting the freedom of Argentines to use their preferred currency, that is, the dollar, Argentina should suspend the BCRA and the pathetic peso and place them inside a museum. It is time for Argentina to officially dollarize. This would be an easy task to accomplish. At the request of then-President Carlos Menem , Dr. Kurt Schuler and I prepared “ A Dollarization Proposal for Argentina, ” originally published in English in Friedberg’s Commodity and Currency Comments Experts’ Report (February 1, 1999).
Although Menem was unable to release the trigger for dollarization in Argentina, it was possible in 1999 and would have worked well, just as it would today. In fact, it would allow Argentina to avoid the monetary chaos, skyrocketing inflation, and subsequent devaluations and defaults that have ruined Argentina since 1999.
Steve H. Hanke is Professor of Applied Economics at Johns Hopkins University and Senior Fellow of the Cato Institute.