Argentina

Argentina is toying with the idea of dollarization - adopting the U.S. dollar as its sole currency. Central bank chiefs from Argentina, as well as Brazil and Mexico, attended a meeting sponsored by the United States Federal Reserve board in Dallas March 6-7 to examine the benefits of dollarization. While this policy has its pros and cons, in the case of Argentina it is economically feasible, even desirable - and therefore expected.

Argentina's new President Fernando de la Rua - still on his political honeymoon - has the political clout to manage the dollarization process. Prior to taking office on Dec. 10, 1999, he boldly promised a growth rate of least 4 percent for 2000. But in order to increase growth, De la Rua must increase Argentina's access to capital and decrease the cost of doing business. Dollarization is an option for achieving these goals.

Perhaps the most alluring aspect of dollarization for the Argentine government is the degree to which it would hitch its economy - which is in recession - to the soaring U.S. one. Such a direct linkage would permanently force Argentina's at times robust inflation in line with U.S. norms. Establishing a single currency regime would lower the cost of trade with the United States. This expanded trade would trigger an economic expansion that recessionary Argentina desperately needs.

More important than increased access to the U.S. market, however, is increased access to U.S. capital - both in the form of direct investment and lending. With the cost of exchanging currency shrinking to zero, North American businesses would have a powerful incentive to sink their resources into the Argentine economy. Furthermore, lending rates to Argentina would drop to U.S. norms, sharply reducing interest rate fluctuations. The reduced cost of borrowing - and increased investor confidence - would spur domestic economic growth throughout the Argentine economy. Cheap, long-term loans would also be available to small businesses and homeowners - something almost unheard of outside of the world's richest, and most stable, economies.

There is, however, a potential downside to dollarization. Argentina would have to abandon all pretense of holding an independent monetary policy, subjecting the country fully to the winds of globalization. This is often perceived as a harsh surrender of national sovereignty. Yet small countries that have dollarized, such as Panama, have seen the sacrificing of monetary policy work in their favor. Moving monetary policy from a heavily politicized domestic authority to an independent foreign authority lessens the threat of politically motivated economic intervention, such as artificial currency devaluations. The idea of U.S. Federal Reserve Chairman Alan Greenspan managing a stable and predictable monetary policy, instead of a local political crony managing a politically expedient one, is attractive to businesses throughout Latin America. This is also true for foreign investors - especially the North American investors who revere Mr. Greenspan as the patron saint of money.

Perhaps the largest leap of faith for countries seeking to dollarize is the loss of a lender of last resort in case of economic crisis. If Argentina dollarizes and surrenders its monetary policy, and then later suffers a crisis, it would be forced to appeal directly to the United States, or more likely the International Monetary Fund, for emergency funding. While still able to run account deficits, the government could no longer print currency as a means of raising revenues. Yet, since printing currency would trigger inflation and capital flight as it has in Russia, this perceived "restriction" is a benefit in disguise.

This does not mean that Argentina would lose control of its economy - far from it. To maintain successful dollarization Argentina would need to hone its fiscal policy as it could no longer depend on its monetary tools. While Argentina already has one of the world's freest economies, losing monetary policy would necessitate an incredibly effective fiscal policy. Tax laws would need to become more efficient and government funding schemes more transparent. Otherwise Argentina simply would not be able to deal with any external economic - or internal political - shocks.

Taking the final step to full, official dollarization would be relatively easy for Argentina. Argentina has maintained its peso at parity with the U.S. dollar for nine years; dollarization would not bring a price shock. Furthermore, maintaining this peg already constrains Argentine monetary policy; a transfer to full dollarization would not be as large a shock as it would be for many other countries. Unofficially, Argentina has already dollarized; 80 percent of bank loans are already in U.S. dollars. Finally, there is the issue of capability. Argentina has large enough dollar currency reserves to buy back all of the pesos in circulation; it could dollarize at any time. It's merely a question of political will.

Another Latin American country, Ecuador, is also moving toward full dollarization - although stumbling toward dollarization would be a more accurate depiction. The Ecuadorian Congress voted March 1 to proceed with President Gustavo Noboa's dollarization plan. While Argentina has a stable economy and a responsible government, neither Ecuador's financial or political houses are in order. Ecuador, while technically having the currency reserves to undergo the process, lacks the underlying economic and political stability to pull off the feat without risking social collapse.

Argentina has recently seen a massive redirection of Argentine investment flow north to its largest trading partner, Brazil. Partly this is due to the more developed nature of the Argentine economy, but mostly it is due to the 40 percent currency devaluation Brazil suffered in 1999 as part of the fallout of the Asian financial crisis. Because the Argentine peso is pegged to a surging U.S. dollar, the cost of doing business in Brazil is currently lower. If Argentina does indeed adopt the U.S. dollar as its sole currency, then its sometimes rancorous economic relations with its Mercosur trading partners - Brazil, Paraguay and Uruguay - should calm slightly.

Argentine dollarization would provide a vast inflow of cheap capital to offset the drain to Brazil and partially offset its dependence on Brazil with stronger links to the United States. This would in turn stimulate Argentina's recessionary economy. In the long term a solid, dollar-denominated Argentine economy with its low interest rates could tempt the rest of Mercosur into considering dollarization as a potential option for their own economies. Uruguay has already called for the adoption of a Mercosur-wide currency. If Argentina dollarizes, the U.S. dollar may well be the only option.

The United States has played coy so far at the prospect of its currency playing an ever-wider role internationally. On one hand, U.S. policy makers would welcome Argentina in a de facto U.S.-led currency zone. Such a move would lash Latin America even closer to the United States and complicate the European Union's bid to sign an association agreement with Mercosur. Yet U.S. Treasury Secretary Larry Summers and Federal Reserve Chairman Allen Greenspan have stated that the United States will not take the situations of other countries into account when drafting monetary policy and will not micromanage their economies.

The real - and unspoken - U.S. concern, however, is what if the rest of Mercosur and Mexico actually follow the Argentine lead? Argentina's economy is less than 4 percent of the United States'; a dollarized Argentina will not significantly affect the United States. But Mercosur and Mexico together amount to almost 20 percent of U.S. GDP. While the expansion of U.S. economic power to such a degree would be welcomed in Washington, such a wide "dollar- zone" would create major headaches for North American monetary policy - regardless of the official line.

The issue comes down to President de la Rua's intentions. Official, full dollarization would strip away the country's few remaining monetary tools in exchange for increased trade, capital flows and efficiency throughout the Argentine economy. While Argentina's economic situation will not force De la Rua to dollarize, it is certainly the fastest, most thorough and most permanent option available for stimulating economic growth. The real surprise would be if De la Rua decided - after nine years of unofficial dollarization - not to complete the process and garner the full benefits for Argentina.