Argentine Currency Board - Flaws in Implementation

Flaws in Implementation

The main qualities of an orthodox currency board are:

• A currency board maintains absolute, unlimited convertibility between its notes and coins and the currency against which they are pegged, at a fixed rate of exchange, with no restrictions on current-account or capital-account transactions.
• A currency board's foreign currency reserves must be sufficient to ensure that all holders of its notes and coins can convert them into the reserve currency (usually 110–115%).
• A currency board only earns profit from interest on reserves (less the expense of note-issuing), and does not engage in forward-exchange transactions.
• A currency board has no discretionary powers to affect monetary policy and does not lend to the government. Governments cannot print money, and can only tax or borrow to meet their spending commitments.
• A currency board does not act as a lender of last resort to commercial banks, and does not regulate reserve requirements.
• A currency board does not attempt to manipulate interest rates by establishing a discount rate like a central bank. The peg with the foreign currency tends to keep interest rates and inflation very closely aligned to those in the country against whose currency the peg is fixed.

The Argentine currency board violated all these rules at one time or another, except that of a fixed exchange rate. Full convertibility with the U.S. dollar became jeopardized upon implementation of exchange rate controls that provided a preferential exchange rate for exports. The currency board was allowed to hold up to one-third of its dollar-denominated reserves in the form of bonds issued by the government of Argentina. It acted as lender of last resort and regulated reserve requirements for commercial banks. And it engaged in monetary policy activities. The impact of all this was to reduce the credibility of the Argentine government's intent, and to put speculative pressure on the peso, despite the peg.