The crises of the second half of the 90’s, tequila effect, Asian crises, Russian and Brazilian have shown the incompatibility of such philosophy, especially in the developing countries. These crises have proven that is not viable to adapt autonomy monetary policies and at the same time maintain fixed exchange rates in a economy of free circulation of capitals. Moreover, once financial globalization is accepted as the most efficient way to attract investment projects and foreign savings, the only valid solutions are the extreme ones. These solutions are flexible exchange rate with autonomy in the monetary policy or fixed exchange rate without monetary autonomy.

In Argentina, the macroeconomic policy makers have decided to renounce to the freedom of monetary policy and the flexible exchange rates for the following reasons:

• A high default risk (spread) applied to the interest rates, which discourage foreign investment
• The lack of credibility in the macroeconomic authorities
• A high inflation which discourage financial planning and reduced the acquisition power of the citizens
• The high costs to the nations wealth (GDP) as a result of external shocks, such as the Brazilian and Asian crises (lost of competitiveness and trading partners)

Reinhart 2000), which obviously led to the application of constitutional compromises to use firm exchange rate system (currency broad). However, we have seen that this mechanism did not bring the benefits that Argentina was expecting.

In this context, new proposals have been discussed about a possible solution for the Argentine crisis. One of these proposals that have caught significant attention is dollarization for Argentina as the new monetary system. Thus, this proposal has deployed several debates among economist and academics. On one hand, several analysts argued that Argentine regime already gave up to its monetary freedom and applied a fixed exchange rate system to bring financial stability to Argentina and it did not work. Therefore, a more radical currency system would not work either. Nevertheless, in spite that the currency broad and dollarization are very similar (at least in a first sight) the differences are quite significant.

The major benefit of dollarization would be, reduced interest rates in Argentina. With no peso-dollar exchange rate, currency risk would be eliminated, and the spread in interest rates between pesos and dollars for loans within Argentina would be closed. In January 1999, the interest rate for interbank loans in pesos was about 1 percentage point higher than the rate in dollars, and the spread was fluctuating around 5 percentage points for 1-year interbank loans. For non-bank borrowers, the spreads are higher. It is true that people who want to pay lower interest rates can borrow in dollars, but that exposes them to a currency risk that many do not wish to take, given Argentina’s long history of devaluations before the Convertibility Law.

By eliminating currency risk, dollarization would reduce interest rates. In consequence, Argentina’s trend rate of growth would be higher and the variability of annual growth would be lower with dollarization than with its currency board system. Indeed, a government memorandum (Ministro de economia de Argentina)estimates that lower interest rates resulting from dollarization would add 2 percentage points to the trend rate of economic growth (Warn 1999). This benefit exceeds the cost of seignorage lost (0.22 percent of GDP).

Even using the conventional benefit-cost framework, as we have just done, leads us to conclude that the benefits of dollarizing Argentina clearly are greater then the costs. However, when evaluating alternative monetary regimes, conventional benefit-cost analysis fails to capture important benefits and costs, namely the needs of the consumers.

The ‘‘consumers’’ of money are those who use it—almost everyone except for young children. Rather than using as their starting point a determination of what characteristics consumers find desirable in money, economists simply assume that a well-intentioned, competent, politically independent central bank would produce the best outcome, and that is where they begin their calculations. In the case of Argentina, this is as unrealistic as assuming that a government-owned telephone monopoly would produce efficient, low-cost service. Argentines have shown that the characteristics they want in a currency are those that the dollar has: low inflation, full convertibility, the prospect of continued good performance in the future, and international acceptability. The Convertibility Law succeeded, where past monetary reforms had failed, because it made the peso a close substitute for the dollar. However, the dollar is still perceived by consumers as being superior to the peso. Dollarization would allow consumers fully to take advantage of the perceived superiority of the dollar.

-Flexible exchange rate: With this exchange rate type, the Central Bank has monetary freedom but the economy could have inflation problems. If it tries to increase the money supply (to finance banks or the government) the interest rates tend to fall, the people send their money to another countries with higher interest rates. This also leads to an increase in the exchange rates and the price levels increase. The Argentine experience has proven that this monetary system does not work in this country, mainly because of the inflation repercussion that it brings. Furthermore, it seems that the Argentines would be reluctant to use this system again.

-Currency board exchange rate system: With this type the Central Bank could control the inflation in an optimal way but it would have less freedom in its monetary decisions. In effect if it tries to increase the money supply (to finance banks or the government) the interest rates tend to fall, the people send their money to other countries with higher interest rates and this leads to fewer credibility in the peso, which means that the citizens would their trust in the value of the peso. Now the Central Bank has to buy pesos bonds with its dollars in its reserves (it compromised to maintain a currency board) and take the pesos out of the economy. The result was a stable currency board but the government lost part of its reserves. Moreover the lost of these reserves was the main reason of the past crisis.

Another objection to dollarization is that it would eliminate the Argentine Central Bank’s capacity to act as a lender of last resort. Contrary to what most individuals think, it is undesirable to have a central bank as a lender of last resort. Most of the expensive rescues of banking systems have occurred under central banking. Argentina, in fact, holds the record for the most expensive bank rescue in proportion to the size of its economy: the banking crisis of 1980–82 cost 55 percent of GDP (Caprio and Klingebiel 1996). Argentina already has in place a liquidity fund of $6.7 billion (BCRA 1998). The key provision of the fund, which was established in December 1996, is something called the Contingent Repurchase Facility. Under this program, the Argentine central bank has the option to sell certain domestic assets for dollars to a group of banks subject to a repurchase clause. As of October 1998, 14 international banks were participating in the facility. The assets underlying the repurchase facility included $6.2 billion in Argentine U.S. dollar-denominated bonds and up to $500 million in dollar-denominated Argentine mortgages. Consequently, the facility can provide emergency liquidity, but it is not a lender of last resort arrangement, which by its nature also provides the government with the power to inflate.

Argentina’s banking system has become very internationalized under the currency board system, with foreign banks accounting for about 41 percent of the banking system’s total deposits and 64 percent of the deposits in private banks (BCRA 1998). This has dramatically increased the banking system’s access to liquidity provided by international capital markets. The Repurchase Facility, along with the extensive internationalization of Argentina’s banking system (which makes the international banks’ head offices, in effect, lenders of last resort to local branches), ensures that arrangements for emergency liquidity are adequate for a dollarized system.

Another objection is that Argentina would be hurt if the dollar someday becomes an unstable currency with high inflation. The solution to this potential problem is to extend the considerable freedom that already exists for people in Argentina to use any currency. Though initially the dollar would be the most widely used currency, people would be free to use whatever currency they prefer. If people wish to make contracts specifying payment of wages, business expenses, or loans in euros, yen, or even Brazilian reals, they should be allowed to do so. That way the Argentine people would be able to use the most stable currencies in the world.

Still another objection is that dollarization is an inappropriate basis for a single currency in the Mercosur, because other countries, especially Brazil, will not dollarize. Again, the goal for Argentina should be the retention of political well-being and the enhancement of consumer well-being. A Mercosur monetary union would not achieve

this, in principle, whereas dollarization would do so, in principle and in practice.

Another factor is that the currency board system retains some features of a C.B, the peso has experienced periodic speculative attacks. Especially during speculative attacks, interest rates in pesos have been much higher than comparable rates in dollars. It seems that dollarization would eliminate the rationale for speculative attacks. However, in a speech made last November, Alan Greenspan, chairman of the Federal Reserve System, said, ‘‘It is questionable whether a sovereign nation, otherwise inclined to economic policies that are ‘off the wagon,’ can force itself into ‘sobriety’ by dollarization’’ (Greenspan 1998: 6). It seems that sound fiscal policies must precede a sound currency, as if the monetary system exerts no influence on government finance.

Argentines know from their own experience, though, that the monetary system does exert considerable influence. It is generally recognized that without the Convertibility Law, economic reforms in Argentina would not have progressed so far and so fast. Other countries have had similar experience. In a study of 98 developing countries during the period 1950–93, Hanke (1999) found that fiscal deficits were, on average, 65 percent larger and 1.4 times more variable in countries with central banks than in those with currency boards or dollarized systems.

Dollarization would not absolutely guarantee sound economic policies, but no system could. The important thing is that dollarization would improve the odds that Argentina would continue to follow sound policies, much as the Convertibility Law greatly improved the odds that Argentina would implement sound policies in the first place. Moreover, sounds policies and their benefits are attainable when the institutions that make them are responsible and effective, once again this is not attainable by a simple change of the currency system. It also seems that issue would have to be individually explore.

Depositors would have no more reason to make mass conversions of U.S. dollar deposits into U.S. dollar notes than they now have to make mass conversions of peso deposits into peso notes. Depositors would also have no reason to switch deposits from some banks to others under dollarization. The assets and liabilities of banks would be the

same as they are now. Only the unit of account would change. Expressed in terms of U.S. dollar values, nothing would change. The investment portfolios of banks, and hence their creditworthiness, would stay the same. Critics will no doubt devise other objections to dollarization, but that is no reason for dismissing dollarization. It is possible to make objections about any monetary system. However, the true test of a monetary system is experience. There is plenty of historical data and current experience with official and unofficial dollarization. No far-fetched conjectures are necessary. If you want to know how dollarization works, look at Panama, Puerto Rico or Ecuador. Dollarization works well there and elsewhere. It does not encounter the problems that critics claim would arise. Purely hypothetical objections are not sufficient to out-weigh the practical success of dollarization.

In conclusion, it has been determined in several aspects why dollarization represents the most advantageous path for Argentina to follow. The cost of losing the seniorage will be offset by the benefits of dollarization such as, low interest rates, no speculative attacks and the tranquility of the consumers. Moreover, the empirical evidence of the viability of dollarizattion in other countries strengths the decision to dollarize. However, we have to remember that the stable currency is not the only part of the blissful triad, Argentina also needs sound institutions in order to make the dollarization work.