Ignorance and Influence: U.S. Economists on Argentina’s Depression of 1998-2002 by Kurt Schuler Econ Journal Watch, August 2005 Appendix 2: Quotations To document statements in the main text, I have quoted at length from some sources. Copyright remains with the copyright holders. Important words or phrases from the quotations are highlighted in yellow; some of my comments are highlighted in blue. Where no page number is given, the article in question was either just one page long or I viewed it through an electronic source, such as Nexis or a Web browser, that did not list page numbers. Pierre-Richard Agénor (Lead Economist and Director of Macroeconomics and Policy Assessment Skills Program, World Bank) “The key elements of the [Convertibility] plan consisted of a fixed exchange rate and a change in the central bank charter. The exchange rate was fixed at 10,000 Australes per dollar, and future exchange rate changes were required to authorized by congress, rather than left to the discretion of the central bank. The Austral was made fully convertible for both current and capital account transactions, and use of the U.S. dollar as unit of account and means of exchange was legalized. More importantly, the central bank was legally enjoined from printing money to issue credit to the government. Money could be printed only to purchase foreign exchange. In effect, this converted the Argentine central bank into a semi-currency board. [Footnote to last sentence above] Several loopholes in the central bank legislation actually gave the Argentine central bank powers beyond those of a pure currency board. Government dollar-denominated debt held by the central bank could be counted (up to a maximum amount) as foreign exchange reserves, and the central bank’s monetary liabilities were permitted to exceed its stock of foreign exchange reserves—by [a] maximum of 20 percent from 1991 to 1995, and 33 percent subsequently—in exceptional circumstances, a measure that was intended to permit the bank to cope with financial distress in the domestic banking system. However, except during the Tequila crisis of 1995 (described below) the foreign exchange cover of the central bank’s monetary liabilities was maintained at 100 percent.” Agénor and Montiel (1999, pp. 386-7) Robert Z. Aliber (professor of international economics and finance, University of Chicago) “’As long as Brazil’s currency was slightly overvalued, Argentine firms weren’t having difficulties in Brazil. Now they are,’ said Robert Aliber, an international economist at the University of Chicago.” Aliber (1999) “Argentina’s attempt to link its peso one-to-one with the U.S. dollar has effectively failed after a 10-year attempt. The economic policy was a ‘fiscal disaster’ said Robert Aliber, professor 1 at University of Chicago’s Graduate School of Business, because of the mismatched exchange ratio. “’In some sense this has been a widely anticipated event,’ he said. To that end, U.S. institutions should be positioned to weather the effects.” Aliber (2001) “In effect, [under a currency board] the central bank gives up any semblance of monetary independence; the money supply increases when the country has a payments surplus and falls when the country has a payments deficit.” Aliber (2002, p. 9) (Aliber does not describe any particular country as having a currency board.) Mark Allen (deputy director, Policy Development and Review Department, International Monetary Fund; deputy director during Argentine crisis) “In most cases, downward adjustment in nominal wages and prices is slow, politically difficult, painful, and leads to a reduction in real growth (as evidenced by Argentina’s difficulties in implementing such policies under the constraints of its currency board.) … “Similarly, Argentina more recently introduced capital controls in combination with a freeze on bank deposits when exiting from its currency board arrangement and suspending payments on its sovereign debt.” Allen, Rosenberg, Keller, Setser, and Roubini (2002, pp. 29, 33) “The plan adopted in 1991 centered on the establishment of as firm a nominal exchange rate as possible, i.e., a currency board peg to the US dollar, macroeconomic policies consistent with this anchor, and a sweeping structural reform programme.” … “The Convertibility Law, involving most of the elements of a currency board,…. However, exchange rate-based stabilizations have a number of costs, including the danger that the residual inflation will push the real exchange rate to a point that it endangers competitiveness.” Allen (2003, pp. 121, 122-3) David E. Altig (vice president and director of research, Federal Reserve Bank of Cleveland) “In 1991, Argentina established a currency board that fixed a one-for-one exchange rate between pesos and the U.S. dollar. To guarantee free conversion at this rate, the Convertibility Law that established the currency board requires Argentina’s central bank to back the peso monetary base fully with reserves dominated in U.S. dollars or in currencies easily converted into dollars. The central bank holds these reserves as dollar-denominated deposits or other interest-bearing instruments. “Although the new monetary institution created by the Convertibility Law is not a pure currency board, such an unadulterated arrangement is a useful benchmark from which to begin thinking about Argentina’s monetary structure. The monetary base of a country with a pure, dollar-backed currency board can change in response to adjustments in U.S. monetary policy, to shifts in overall demand for dollars, or to swings in the worldwide distribution of dollars. Holding all else constant, for example, a U.S. monetary expansion would raise the U.S. price level relative to the Argentine price level and put downward pressure on the peso price of dollars. To defend its peg, the Argentine currency board would trade pesos for dollars, effectively expanding its own monetary base in concert with the change in the supply of dollars. 2 “Though not a pure currency board, Argentina’s arrangement ties its monetary policy to that of the United States. By 1995, its inflation rate approached U.S. levels. By adopting a currency board, Argentina traded monetary independence for the credibility associated with Federal Reserve policies. … “Argentina contemplated these problems [of the tradeoff between rules versus discretion in monetary policy] when instituting its monetary reforms and, in contrast to a pure currency board, elected to retain some latitude for discretionary policies. The central bank may, for instance, hold up to one-third of its reserves in dollar-denominated Argentine government bonds, but it may not increase its holding of these bonds by more than 10 percent over the previous year’s average (except in emergencies and then only with congressional approval). Although the government has never used this provision, transacting in Argentine government debt allows the central bank to alter the monetary base.” Altig and Humpage (1999, pp. 2-3) “Even at the height of success, however, there were indications that the currency board was not an absolute panacea. The perception that the peso remained a relatively risky bet was hard to shake, and investors in peso-denominated securities demanded higher interest rates as compensation for bearing this risk. What’s more, the magnitude of the risk premia tended to be quite volatile, suggesting that the economy remained susceptible to speculative attack. “In January 1999, then-President Carlos Menem proposed complete dollarization, in effect eliminating the peso entirely. Although dollarization would have had little technical advantage over the existing currency board arrangement, many proponents of dollarization argued that markets had retained some residual doubt about the long-run viability of the board, doubts that only complete elimination of a circulating peso would vanquish. “But the drive for dollarization was not to be, and the fears that the currency board would prove unstable were all too prophetic. As of February 11, the peso was wholly untethered from the dollar, and the last vestiges of the currency board, in the process of being dismantled since late last year, were finally reduced to rubble. “The advocates of dollarization may have seen it coming. Argentina had begun the recession from which it has yet to recover in mid-1998, as fears mounted that the faltering Brazilian economy would place irreparable strains on the Argentine economy. The problems of the country, however, appear to be more fundamental than the details of its monetary arrangements. Writing in the January 9 edition of the Wall Street Journal, the Cato Institute's Brink Lindsey quoted a survey conducted by Harvard University and the World Economic Forum’s 2000 Global Competitiveness Report showing that, of 59 countries studied, Argentina ranks ‘40th in frequency of irregular payments to government officials; 54th in the independence of the judiciary; 55th [in] litigation costs; 45th for corruption of the legal system; and 54th in the reliability of police protection.’ (The questions of the survey were asked such that high numbers are bad.) “These statistics reveal an overwhelming fault in Argentina’s political infrastructure. It is not surprising that truly independent central banking could not be sustained in such an environment. As if to underscore the point, the disintegration of the currency board took shape in May 2001 when Fernando de la Rua dismissed Pedro Pou, the central bank governor, for resisting attempts to weaken the country’s promise of peso parity with the dollar. “In the case of Argentina, the reforms that gave rise to the currency board were not sufficient in the absence of broader institutional reform. But that fact should not mislead us into 3 the false belief that long-term prosperity can be achieved in Argentina (or any country) without a strong, stable, and credible monetary standard. A currency board, dollarization, or the like may not be a sufficient condition for prosperity, but it is certainly a necessary one.” Altig (2002a, p. 2) “The list of currency boards shrunk early this year with the very visible departure of Argentina.” Altig and Nosal (2002, p. 1) Caroline Atkinson (senior director of Stonebridge International, formerly [1997-2001] U.S. Treasury, including senior deputy assistant secretary for international affairs of U.S. Treasury, also formerly [1983-1994] assistant director of International Monetary Fund) “Argentina’s widely signalled collapse was precipitated by the kind of policy conflict that the IMF and others have long warned against: an attempt to maintain a fixed exchange rate that was incompatible with the growth needed for political survival. The international community can be faulted for financing this attempt for too long, or for going along with a series of unrealistic fiscal targets as market financing for the budget dried up. But the decision to stick with the currency board was made in Buenos Aires, not dictated by Washington.” Atkinson (2002) Nancy Neiman Auerbach (assistant professor of international political economy, Scripps College) and Aldo Flores-Quiroga (assistant professor, Claremont Graduate University) “The case of Argentina, which through a currency board officially tied its currency to the dollar from 1991 to 2001, illustrates both the macroeconomic costs and benefits associated with dollarization. The currency board adopted a decade ago successfully ended Argentina’s bouts with hyperinflation, but the inflexibility of the exchange rate is also ‘largely to blame for the country’s inability to cope with a run of bad news,’ most notably the devaluation of the Brazilian cruzado.” Auerbach and Flores-Quiroga (2003, p. 268) (Actually, Brazil’s currency was by then called the real.) Sebastian Auguste, Kathryn M. E. Dominguez, Herman Kamil, and Linda L. Tesar (all University of Michigan; Dominguez is professor of public policy and economics and Tesar is professor of economics) “Argentina’s currency board was established in March 1991, triggering a stock market boom that lasted until June 1992.” Auguste and others (2003, p. 4) (This is brief remark is all the discussion of the convertibility system they have, other than to note that it ended in January 2002. The Convertibility Law was passed in March 1991, but the convertibility system began operating on April 1, 1991.) Werner Baer (professor of economics, University of Illinois at Urbana-Champaign), Pedro [Luis] Elosegui (Universidad Nacional de la Plata, Argentina), and Andrés Gallo (assistant professor of economics, University of North Florida, Argentine origin) “One of the main features of neo-liberalism in Argentina was the ‘Convertibility Plan,’ which was basically a ‘Currency Board’ system. The essential feature of this plan was to tie a new Argentinian peso to the dollar on a one-to-one basis, eliminate the power of the government to finance budgets through the Central Bank and restrict new money creation to the inflow of foreign exchange. … 4 “As the peso was initially substantially overvalued (due to an initially lingering inflation rate that was higher than that of some of its major trading partners and to the large capital inflows in the first years of the Convertibility Plan), the resulting trade deficits made the government try to counteract this by occasionally reverting to higher tariff levels (or artifices, such as special taxes on certain foreign products, which amounted to higher tariffs) and/or the use of non-tariff barriers to imports. Measures were also tried to counter the overvaluation by increasing productivity levels, which contributed to growing levels of unemployment.” Baer, Elosegui, and Gallo (2002, pp. 64, 67) Martin Neal Baily (senior fellow of Institute for International Economics, formerly [1999- January 2001] chairman of Council of Economic Advisers, also formerly professor of economics, University of Maryland) “Argentina had taken the powerful but dangerous medicine of fixing its exchange rate to the US dollar in order to establish credibility for its monetary policy and reduce inflation. It had also taken major steps to establish a sound financial system, encouraging international banks to take over Argentine banks and ensuring these banks had adequate reserves and were well regulated. Given that growth was strong over this period, it should have been possible for government deficits to remain low and for the debt to GDP ratio to grow modestly or even decline. That was not the case. The debt to GDP ratio rose from 29 percent in 1993 to 41 percent in 1998, despite the fact that reported government deficits were rather small. “A serious problem in Argentina, paralleled until recently in Brazil and Russia, is that spending decisions are made at the regional or local level, but the central or federal government is responsible for the resulting debts….This problem is intensified if a significant faction of the debt is held internationally and denominated in dollars, as was the case in Argentina. As confidence erodes, interest rates rise and the problem of debt service increases, even if the level of debt to GDP is not high by the standards of developed countries. Argentina became vulnerable to crisis because of its fixed exchange rage and its fiscal problems. “In early 1999 the Brazilian real was allowed to float and the exchange rate dropped sharply….the Argentine peso had become unsustainably overvalued….And in the course of responding to the crisis, the government has managed to bankrupt its previously sound banking system.” Baily (2003, pp. 27-8) Tomás J. T. Baliño, Charles Enoch, Alain Ize, Veerathi Santiprabhob, and Peter Stella (all International Monetary Fund at the time) “Currency board arrangements (CBAs) have undergone a revival. Four countries have undertaken IMF-supported adjustment programs with a CBA, Argentina, Djibouti, Estonia, and Lithuania. … “In its simplest form, a CBA can be defined as a monetary regime based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate, combine with restrictions on the issuing authority—the currency board—to ensure the fulfillment of its legal obligations. This structure implies that domestic currency can be issued only against foreign exchange and that it remains fully backed by foreign assets. Thus it eliminates traditional central bank functions like monetary regulation and the lender of last resort (LOLR); such a CBA is defined in this paper as a ‘pure CBA.’ … 5 “Even though CBAs do not require a full-fledged central bank for their operation, the currency boards of Argentina, Estonia, and Lithuania were established in institutional frameworks encompassing an existing central bank, which retained some or all of its traditional functions. … “In addition, the backing rule eliminates (or strictly limits, when less than 100 percent of the base is backed) the scope for issuing unbacked monetary liabilities, hence ensuring that the CBA does not run out of foreign reserves to maintain the parity. While the central bank may still give credit to banks (or government), it can only do so if it holds foreign reserves in excess of what is necessary to back the monetary base.” Baliño and others (1997, pp. 1-4) (Actually, an orthodox currency board does not give credit to banks or the government even if it has reseves exceeding 100 percent of its monetary liabilities.) Robert J. Barro (professor of economics, Harvard University) “For Argentina, the soundness of the currency is guaranteed by the convertibility law (1 peso = 1 U.S. dollar) and the central bank’s charter, which requires full backing of the monetary base by international reserves. Some questions arise about the definition of these reserves (whether they should include a small quantity of dollar-denominated government bonds and whether they should subtract obligations to international organizations), but the important point is that changes in the monetary base have been closely linked to movements in the balance of payments. Thus, figure 3 shows that the movements in the base since 1991 have nearly matched the variations in international reserves [apparently these are gross reserves, because they always exceed the monetary base for the period January 1991-Apri 11, 1995 that the figure covers]. In this sense, the Argentine monetary system has functioned as a currency board. “(A currency board is an arrangement whereby the monetary authority issues paper currency notes only at a fixed rate of exchange with a designated reserve medium, such as gold or a specified foreign currency. The domestic quantity of money in the form of currency rises only when people bring to the authority an equally valued amount of reserves, and the domestic quantity of currency falls only when people bring back these notes to exchange for reserves. If the monetary authority begins with reserves that are at least equal in value to its outstanding currency, then it always has enough reserves to buy back all of this currency at the designated exchange rates. Therefore, it can always maintain the exchange rate between currency and reserves as long as it never cheats by using reserves to buy something other than its currency. Problems can arise, however, if the authority uses reserves for other purposes, for example, to make loans to governments or private banks.)” Barro (1996, pp. 45-7) “The [Mexican] bailout also did not avoid sharp economic contraction and high inflation—both much worse than in Argentina, which ties its money supply directly to its international reserves.” Barro (1998) “Argentina’s disciplined monetary policy stands in stark contrast with that of some of its neighbors. At the beginning of the 1990s, Argentina enacted an array of economic reforms, including a currency-board type of monetary system. This regime ensured a fixed exchange rate—one peso to the dollar—and thereby promoted stability in prices and interest rates. Other Latin American countries, such as Brazil and Mexico, instituted some economic reforms but failed to make basic changes in monetary institutions. These countries adopted the worst-of-all- 6 worlds system in which exchange rates neither float nor are genuinely fixed. Hence, they have suffered from volatility in exchange rates, inflation rates and interest rates.” Barro (1999) “Argentina adopted a currency board in 1991. The Argentine economy did well on average until 1999, but there is substantial controversy as to how much the current recession stems from this link to the strong U.S. dollar. I would argue that Argentina’s economic future would be jeopardized by elimination of the currency board and that a better course would involve full dollarization.” Barro (2000) “Cavallo’s program can be understood as a reaction to two concerns, the size of the fiscal deficit and the overvaluation of the currency. Wary of the fate of Lopez Murphy, Cavallo proposes to end the deficit not by trimming public outlays but by raising taxes. The main new revenue device is a levy on financial transactions through the banking system. “There are several problems with this approach. One is that the economy would actually benefit more from lower spending than from higher taxes. In fact, Argentina needs to boost its low level of investment by cutting the high tax rates on business income. Another problem is that the new tax will highly distort the financial system, pushing Argentines to use offshore banks and pay in cash. “Cavallo also seeks to ease worries about default on public debt by persuading corporations and banks to hold more government bonds. The payoff to the banks—if the central bank can be induced to ease its tough policy on reserve requirements—is that these bonds would count, in part, as reserves. Unfortunately, this change could make banks riskier enterprises. “The appreciation of the peso—caused by the dollar link and the strength of the dollar— has made Argentinean goods and labor too expensive. The market reaction is for Argentina’s prices and wages to fall, but this deflation takes time, and unemployment rises in the meantime. The challenge is to avoid the contraction without jeopardizing currency convertibility, the central pillar of the 1990s revival. “Cavallo’s proposals tinker with convertibility without abandoning it. He tries to devalue without officially devaluing by enacting a sharp rise in import duties on consumer goods. The adverse consequences of this protectionism are well known, and the announcement that the tariffs are temporary is not reassuring. “Cavallo wants to replace the peso’s link with the U.S. dollar with a tie to a 50-50 dollar/euro basket, but only after the euro appreciates to parity with the dollar. The inclusion of the euro is understandable because Argentina's trade with the euro zone has been comparable to its trade with the U.S. However, the timing is odd if, as President Bush just proposed in Quebec, we are headed for a Free Trade Area of the Americas. The idea of waiting for dollar-euro parity is also confusing. If Cavallo knows that the euro will appreciate, then he could solve Argentina's fiscal problems by speculating in the euro. “Cavallo’s plan is especially puzzling because the fiscal deficit (2% to 3% of GDP) and deflation are not much different from previous years in which the economy was growing. The crisis really is one of confidence, but financial markets would be reassured more by a coherent plan for reform of state spending, rather than a short-term revenue fix by hiking taxes. Confidence also requires maintenance of dollar convertibility, but announcements of new kinds of pegs, combined with pressures on the central bank to ease, undermine this confidence. That is why interest rates in Argentina are so high. 7 “I would have preferred a bolder plan: full dollarization of the Argentine economy, subject to negotiations with the U.S. to extend free-trade status to Argentina. This deal could also include compensation for conversion to the dollar.” Barro (2001a) (I consider an appeal to “the strength of the dollar” deficient as a definition of overvaluation because it is not specific about what measurement it uses.) “When Mr. Cavallo was reappointed economy minister in March, many observers, including me, were optimistic that he would restore Argentina to economic soundness. However, the initial proposals were disappointing--a new tax on financial transactions, duties and subsidies on foreign trade, tinkering with the currency board--and financial markets were not impressed. Missing was a commitment to curb government spending and, thereby, achieve fiscal balance. “Since 1991, Argentina has been operating under two key principles for the public sector. The first is ‘Do not devalue,’ enshrined in the convertibility law, which created a type of currency board that fixed the value of the peso at $1. Reinforcement comes from the widespread dollarization of the economy. Here, most short-term benefits from devaluation and inflation are eliminated. In fact, the many dollar obligations of banks and companies imply that devaluation would cause a spate of bankruptcies. Hence, the usual temptation to devalue and inflate does not exist, and this absence of temptation strengthens the credibility of the convertibility law. … … The simple and clear convertibility law has been a pillar of Argentina’s enhanced credibility during most of the ‘90s. Maintaining this credibility is more important than attaining a somewhat better form of currency basket. Instead of changing the basket, my preference would be to opt for a full dollarization that included the use of U.S. dollar bills in Argentina.” Barro (2001b) “In addition, several countries have adopted currency boards, including Hong Kong, Argentina, and Lithuania with the dollar and Estonia and Bulgaria first with the German mark and later with the euro.” Alesina and Barro (2002, electronic source, no page numbers) Gary S. Becker (professor of economics and sociology, University of Chicago, Nobel Memorial Prize winner) “Argentina tamed inflation by taking control of the peso supply. The government set the peso at a fixed rate of exchange of one to one with the dollar and fully backed the issue of pesos with dollar reserves. Its money supply can increase only when foreign reserves grow, either because of capital inflows or an excess of exports over imports. Using an arrangement similar to Argentina’s, Brazil drastically cut its inflation rate from over 900% in 1994 to 10% in 1996, and a still lower rate so far in 1997.” Becker (1997) “The world financial crisis also affected Argentina, but its experience offers an instructive contrast to Brazil and these Asian nations. Argentina's finances so far have survived in much better shape mainly because it is committed to a rigidly fixed exchange rate between the peso and the dollar. Not only is the rate pegged at one-to-one, but all domestic transactions can be made in either currency, and local deposits are held in dollars as well as pesos. The government fully backs all pesos in circulation with dollar reserves, which prevents arbitrary printing of pesos to finance government spending.” Becker (1999a) 8 “By contrast [with flexible exchange rates], rigidly fixed rates—either via currency boards, as in Argentina and Hong Kong, or through adoption of one of the international currencies (so-called ‘dollarization’)—do prevent countries from financing expenditures simply by printing money. These systems require nations to have foreign reserves as backing for their currencies. Dollarization is being discussed by Mexico and Argentina to impose more stringent controls over state spending.” Becker (1999b) (I consider this passage plus the 1997 passage barely adequate as a definition of a currency board.) “Others attribute Argentina’s collapse to convertibility because the fixed exchange rate raised the cost of its goods on world markets as the dollar gained in value in the 1990s. Clearly, Argentina could have benefited by floating the peso earlier, perhaps in 1999, when Brazil devalued. However, I do not believe an overvalued peso was the major contributor to Argentina’s current economic difficulties. Exports account only for some 10% of the nation’s GDP and rose as the dollar appreciated.” Becker (2002) (I consider an appeal to the strength of the dollar deficient as a definition of overvaluation because it is not specific about what measurement it uses.) Andrew Berg (division chief, Development Issues Division, Policy Development and Review Department, International Monetary Fund; formerly [2000] deputy assistant secretary for East Asia and Latin America, U.S. Treasury) “Meanwhile, it has become clear that even currency boards are not immune to costly speculative attacks: for example, Argentina and Hong Kong SAR suffered from episodes of financial contagion in recent years that resulted in sharp increases in interest rates and recessions.” … “Is dollarization, then, a better exchange rate regime for developing countries? To simplify the discussion, we compare the merits of dollarization to those of its nearest ‘competitor’—the currency board. Under a currency board arrangement, the monetary authorities commit to trade foreign exchange for domestic currency on demand at a fixed rate of exchange. This is the only mechanism the central bank can use to increase the base money supply—there is no extension of domestic credit to the government or banks, for example. Thus, the domestic currency is fully backed by a corresponding stock of foreign exchange. A focus on comparing dollarization to currency boards captures the main implications of dollarization and how its effects differ from those of adopting a firm peg. Furthermore, much of the current discussion about dollarization has been motivated by suggestions that Argentina should take the next step: moving from its currency board, with a one-to-one fix between the peso and the dollar, to full dollarization.” Berg and Borensztein (2000, pp. 38, 39) “In Argentina, both peso- and dollar-denominated interest rates have tended to come down since the convertibility plan (currency board) was implemented in 1991. ... “Under the rules of the currency board the [Argentine] government is required to hold sufficient foreign reserves to back the domestic currency, and thus cannot ‘consume’ the annual issue of currency by financing public spending, for example.” Berg and Borenszstein (2003, pp. 75, 98 n. 12) 9 “In early 2002, Argentina’s 11-year-old currency board system collapsed during an intense financial crisis.” Berg, Borensztein, and Mauro (2003, p. 24) C. Fred Bergsten (director, Institute for International Economics, formerly assistant secretary for international affairs, U.S. Treasury) “Superficially, the major country vulnerable to a spillover effect might be thought to be Argentina, because it is the only other prime case with a large current account deficit and a fixed exchange-rate ‘anchor.’ A closer analysis suggests that Argentina is in fact much more resilient than the Mexican case. Its current account deficit is only about one-third as large relative to GDP. Its reserves are high. Its currency board system precludes a rapid rundown in reserves without a corresponding reduction in the money supply, which would induce higher interest rates, price restraint, and other partly corrective mechanisms. Importantly, Argentina already stretched out its domestic short-term debt in the Bonex plan of 1989, so it does not have large amounts coming due posing exchange market pressure.” Bergsten (1995, electronic source, no page numbers) “If a country wants to avoid the costs of both currency flexibility and capital controls, and therefore seeks maximum credibility for its fixed exchange rate, one approach is to install a currency board as in Argentina since 1991 and Hong Kong since 1983. Under that approach, a country only issues local currency that is fully backed by a foreign currency (the dollar in both these cases) at a fixed rate. Such an arrangement proscribes the national authorities from changing the rate or conducting an autonomous monetary policy. The currency board thus substitutes for a central bank (which inter alia means that the country will probably not have a lender of last resort to respond to internal financial crises, a point to which I return below). “Even a currency board may not achieve full credibility, however. The country could change the laws by which the board was established, or at least the ironclad rules under which it is supposed to operate. Even Argentina, whose currency board has achieved considerable credibility, still experiences interest rate increases of about 3 percent whenever US interest rates rise by 1 percent—whereas dollarized Panama experiences a rise of less than 0.5 percent. … “Fixed rates, unless carried to the extreme of monetary union, as in Europe, or a currency board, as in Argentina or Hong Kong, have proved too prone to degenerate into costly over- and undervaluations.” Bergsten (1999, electronic source, no page numbers) “Argentina had a history of hyperinflation. They wiped that out in a stroke by pegging their currency to the dollar and essentially importing the stability in prices that we experience in the United States. The problem was that they had no exit strategy from that rigid arrangement. “Over the next few years, Argentine inflation, though it had come down a lot, was still much higher than inflation in the United States and other countries. But with the rigid exchange rate relationship, Argentine products became increasingly overpriced in world markets. They lost export sales. Imports became cheap and flooded in. Their trade deficit soared. It weakened their economy and eroded their reserve. In addition, they were unable to conduct any kind of domestic monetary policy to respond to the problem.” Bergsten (2001) (I consider this definition of overvaluation as deficient because it does not specify what index is involved.) 10