Diego Giudice/Bloomberg
Argentina and its peso are in trouble, again. By officially replacing the peso with the U.S. dollar, Argentina’s peso nightmare would end. But, in a country in which fiscal fiddlers know many tricks, some fiscal rules must also be added to the prescription.
Dollarization should impose a hard budget constraint on Argentina. Under dollarization, which exists in 33 countries, hard budget constraints are imposed because dollarized countries must finance government spending by taxing or borrowing in either domestic or international bond markets. They cannot finance government expenditures by using a central bank, which issues a domestic currency. As a result, fiscal deficits, when they occur, tend to be relatively small. But, there has been one noteworthy, unusual case: Zimbabwe. This case merits our attention.
In 2008, Zimbabwe suffered the second most severe episode of hyperinflation in recorded history. Zimbabwe’s annual inflation rate peaked in November 2008, reaching 89.7 sextillion (10^21) percent. With prices doubling daily, Zimbabweans refused to use the Zim dollar, and Zimbabwe was spontaneously dollarized. In January 2009, the government adopted the U.S. dollar for its accounts, and dollarization became official. With that, a hard budget constraint was imposed on Zimbabwe.
Not surprisingly, Zimbabwe’s budget moved toward balance and the economy boomed. But, when President Robert Mugabe’s party, ZANU-PF, regained control in Zimbabwe in 2013, government spending and public debt surged. To finance its deficits, the government created a “New Zim dollar.” The New Zim dollar is issued at par to the U.S. dollar, but trades at a significant discount to the greenback. As a result of the issuance of the New Zim dollar, Zimbabwe was not longer purely dollarized. The resulting explosion in Zimbabwe’s total money supply created Zimbabwe’s second hyperinflation in less than a decade in October 2017.
There are three important takeaways from Zimbabwe’s experience with dollarization. Firstly, when Zimbabwe was actually dollarized, a hard budget constraint was imposed and budgets were controlled. Secondly, after the New Zim dollar was issued, pure dollarization and the hard budget constraint were abandoned. And thirdly, to ensure that hard budget constraints go hand-in-glove with dollarization, national and provincial governments must be prohibited from issuing any form of “money”, such as script, for example.
This prohibition is particularly important in countries with a long history of fiscal shenanigans, like Argentina. To appreciate Argentina’s fiscal indiscipline, just take a look at its recent deteriorating fiscal performance.