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Global Economics - Essay Example

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The World war II saw off not only thousands of brave soldiers but also saw off many currency boards riding back on the winds-of-change euphoria that was just beginning to catch on. Perhaps unfairly, many associated the then existing boards with imperialism…
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Global Economics

Download file to see previous pages... The recent fascination appears to have been inspired by their success in dealing with hyperinflation in several countries such as Argentina and Bulgaria. Argentina did in fact abandon its currency board sometimes back in 2002 after it experienced one of it's worst recession. Lithuania and Estonia also turned to currency boards to obtain credibility for their newly established countries. The renewed appetite for fixed exchange rate regime justifies a closer look at ideal conditions for their establishment, with particular interest to the Argentina's experience.
A currency board combines three aspects; one, the exchange rate is fixed to an anchor currency. Secondly, there must be automatic convertibility- it should be always possible to exchange local currency at the fixed rate and thirdly, there should be a long term dedication to this system. The fixed exchange regime that that currency board imports is usually appropriate for small economies with fragile central banks. The fixed exchange rate regime will only be effective if there are sufficient foreign exchange reserves to cover the local current issued.
A fixed exchange rate system will be of no use if a country is unable to maintain a sustainable exchange rate to the anchor currency. This might cause serious balance of payment problems if the local currency is overvalued. Argentina paid scant respect for these economic principles that precipitated its financial crisis of 2002. The peso was locked at one US dollar since 1991, when then the currency board was established. Because of this overvaluation, Argentina exported too little and imported too much. The manufactured balance of payment problems rendered it difficult for the country to earn the foreign exchange it needed to repay its foreign debts.

Usually, currency boards have the capacity to instill confidence in the public and financial markets because of the certainty of payment adjustment mechanism. However, experiences with Argentina and Hong Kong shows that currency board are not immune to speculative tendencies induced by fear of devaluation. Devaluation did actually take place in Argentina in 2002. Though this was meant to help resolve the countries balance of payment problems, it rendered many businessmen who had borrowed in foreign currency bankrupt. It is also essential for the fiscal policy of a country to be disciplined by the establishment of a currency board and this requires political will from the establishment. At least initially, Argentina bureaucrats played by the rules of the game. But they were perhaps emboldened and the discipline was lost in the late 90's when Argentina picked where it had left from and proceeded to ruin its economy by running persistent deficits.

Argentina Convertibility Plan: Mission Impossible.

The convertibility plan got its name from the currency board arrangement that was at the centre of economic program in Argentina. At first, it experienced a measure of success and was credited with the growth and stability experienced there in the first half on the 1990's. The initial success, which saw the growth rates going up to 9 percent in 1994, momentarily made Carlos Menem, the then President, and Domingo Cavallo, the then minister of finance heroes in Argentina. The latter years were far from rosy. It's hard to put a finger at what really went wrong and some things even surprised seasoned economists, like the fact that ...Download file to see next pagesRead More
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