South-Western College Publishing - Economics  
Peso, No! Dollar, Si?
Subject Foreign Exchange Rates and Markets
Topic International Finance
Key Words Monetary Policy, Interest Rates, Currency
News Story

The Argentine government has proposed dropping the Argentine peso and adopting the U.S. dollar as its national currency. Argentina already pegs its currency to the dollar in order to establish a stable exchange rate and reduce inflation. But the collapse of Brazil's real last month has led many in Argentina to fear that they will be the next target of currency speculators. Adopting the dollar as the national currency would immunize Argentina against the kind of financial crisis that has affected Brazil. A dollar currency would, it is hoped, establish confidence among investors and lower interest rates. There is opposition to this plan, as many Argentineans fear becoming the 51st state.

Adopting the dollar poses a number of challenges. Some argue it would lead to a loss of national pride and, more importantly, a loss of control of domestic monetary policy. The significance of these arguments may be overstated. Since 1991, when Argentina pegged the peso to the dollar, the government surrendered its control over monetary policy. A pegged exchange rate means that the government has to have $1 for each peso that it issues. The dollar has, in effect, become Argentina's second currency. Car loans, bank loans and more than half of all bank deposits are in dollars. Most businesses accept dollars and local cash machines also provide dollars.

Pegging the peso to the dollar makes the peso more resistant to fluctuations, but many argue the benefits of adopting the dollar. For example, although Argentina's fiscal deficit is small, interest rates are twice that of the U.S. This is because there is the fear that the government will abandon the peg in the face of a crisis and print money. If Argentina is successful in adopting the dollar and avoiding financial chaos, others may follow.

(Updated March 1, 1999)

Questions
1. What are the benefits stated in the article of Argentina's adopting the dollar as its national currency? What are the potential drawbacks?
2. Suppose that Argentina's economy was in recession. What policies could Argentina still pursue to increase aggregate demand?
3. How will Argentina acquire the needed dollars?
Source Anthony Faiola, "A Currency Affair", The Washington Post, February 3, 1999.

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