Listener 9 February 2002.

Keywords: Globalisation & Trade; Macroeconomics & Money

Street demonstrations and the fall of four presidents in a fortnight tell us something is desperately wrong with the Argentine economy (which, with 56 million people, is the world’s 17th largest economy on some measures). It is a century since the expression ‘as rich as an Argentinian’ was in vogue, and many things have gone wrong since. But the precipitant of the recent crisis was the ‘currency union’ with the United States. The Argentinians had abandoned an independent currency and locked their peso to the US dollar. This ‘dollarisation’ is much stronger than pegging the exchange rate, as occurred in New Zealand before 1984. In a currency union there is a common currency – in effect the US dollar was the Argentinian currency, although they used a ‘currency board’ so that while there was a local currency, the ‘peso’, all financial contracts were effectively written in US dollars. The arrangement has the advantage of price stability if prices in the primary currency (the US dollar) are stable.

When the US dollar appreciated relative to the rest of the world, the peso lock-stepped up too. Suddenly the Argentinian exporters found they could not afford to export, while their domestic industries were destroyed by a flood of cheap imports. (Brazil began selling meat to Argentina.) Unemployment doubled. The obvious solution was to devalue the peso, but that is impossible in a currency union. Those who had peso deposits in banks wanted to convert them into US dollars before the devaluation. The government slapped on financial controls which had bizarre impacts: small businesses which traded in cash rather than credit found they had no customers. At the same time, people’s debts – their home mortgages – were denominated in US dollars, so a devaluation increased their debt burden. Even if you had a job you might wake up one morning to find your debt servicing had increased by around 50 percent. People took to the street, governments fell, Argentina reneged on its international debt repayments, and the peso was clumsily devalued. (The banking system may even collapse.) The currency union was destroyed forever – or at least until the Argentinians forget.

Twelve countries of the European Union have recently formed a currency union. They took a further step at the beginning of the year when they introduced EU wide notes. Could they too have a similar crisis? It is much less likely. The European economies are far more dependent on each other’s markets. (Only about a tenth of Argentine exports go to the US). There is a common labour market, so the unemployed can move to areas of labour shortage. (Argentinians cannot move to the US.) There is an, admittedly weak, fiscal union, which means that transfers could be made to struggling regions. (At best the Argentinians could only get international loans, which have to be paid back.) The fault is not that of the US. Argentina unilaterally locked to the US dollar, without any encouragement from America (other than from its right-wing ideologists).

Could this happen in New Zealand? It has. Until 1933 New Zealand was in a currency union with Britain. A different shock – compounded by a world depression – led to similar economic stress, including the Queen Street Riot. Could it happen again? Yes, if we form another currency union.

This is the official policy of Business New Zealand, who want a common dollar with Australia. (About a fifth of our exports go there.) A 1998 report by Victoria University of Wellington’s Institute of Policy Studies vigorously championed an ANZAC dollar. (Others at the time favoured an ANZUS one.) This column did not review the report because its monetary theory seemed exceptionally muddled, and there was no reason to waste the reader’s patience. But even the most superficial reading then would have observed the report paying little attention to the lessons that could be learned from the 1930s, which would have flagged that the report’s uncritical support for the ANZAC dollar was unwise. Today’s reader might reflect that there is nary a hint in the report that the sort of crisis which hit Argentina was a possibility under a currency union. The report is not the deliberation of policy analysis, but the rhetoric of policy advocacy.

When an economy is going well there is a wide range of economic managements which appear to work, and it is straightforward to advocate any one of them. It is when the vicious external shock happens – typically about once a decade for New Zealand – that the management regime really matters. When the sea is calm, the captain and steering hardly count. In stormy seas differences in policy quality come into their own. As Keynes said ‘economists set themselves too easy a task if in tempestuous seas they can only tell us that when the storm is long past the ocean is flat again.’