Von Hayek and private currencies

B Venkatesh

DID you know that certain provinces in Argentina had their own currencies? Why have private currencies? The answer lies in the monetary system Argentina followed called the currency board.

In this system, the monetary authority promises to exchange the local currency for the reserve currency at a predetermined exchange rate.

In the case of Argentina, the exchange rate was one US dollar for one peso. The monetary authority had to ensure, therefore, that it had adequate dollars to match the pesos in circulation; otherwise, it would have found it difficult to pay those who demanded dollars in exchange for pesos.

The problem was that the Argentinian economy had been doing badly. The only way the government could pull the economy out of recession was by spending more, which meant printing pesos.

But the currency board system demanded that the government first find dollars to backup the likely increase in local money supply due to printing pesos.

The poor economic conditions led to a general belief in the country that the government might devalue the peso. Devaluation means one peso will not be exchanged for one dollar; rather, it may take 1.5 or 2 pesos to buy one dollar.

The fears of devaluation prompted the people to exchange their pesos for dollars at the rate under the currency board. This led to lower supply of pesos in the economy, as more people held dollars.

It also meant that the various provinces could not pay their expenditure by pesos, as the currency was in short supply. The provinces, therefore, began issuing their own paper currencies to solve the short supply in pesos.

Even certain provinces in the US issue such paper currency, for different reasons of course. For example, the community in Ithaca, New York has its own currency called the Ithaca Hours, besides the US dollars.

The concept is not new. Way back in the 1960s, the Austrian economist, Von Hayek, advocated use of private currencies for an efficient monetary system.