200711 Alternative Currencies in Argentina.pdf

This article, Alternative Currencies in Argentina: Response to a Crisis (Brien Desilets, November 2007), examines Argentina’s monetary crisis of 2001–2002, when the collapse of the peso’s dollar peg, capital flight, and frozen bank accounts left the economy starved of liquidity. To fill the gap, the federal government issued “lecops” while provinces created their own quasi-currencies, such as “patacons” and “cecors,” which at their peak equaled nearly half the pesos in circulation. These instruments, often accepted for taxes and wages, circulated at discounts depending on their utility and geographic reach, helping maintain economic activity when barter markets proliferated. The article applies the Kiyotaki-Wright model to explain how pesos remained universally acceptable while alternative currencies circulated more narrowly, and it explores whether their issuance mitigated contraction or fueled inflation, which peaked at over 40% in 2002. Comparisons are drawn to local currencies in the post-Soviet space and U.S. private currencies during 19th-century banking crises. The paper concludes that while alternative currencies may have worsened inflation, they sustained local economies more effectively than barter, representing both a disguised fiscal adjustment and a pragmatic response to systemic monetary failure

1. ALTERNATIVE CURRENCIES IN ARGENTINA :
RESPONSE TO A CRISIS
1

Brien Desilets
November 2007 (Draft March 2006)


Background

In March 1991, Argentina introduced its currency board arrangement which included a
peg to the US dollar (USD). The currency board and peg were instituted in reaction to a history
of high inflation culminating in the hyperinflations of 1989-1990
2
. The arrangement lasted for
more than ten years and, combined with other government policies, facilitated spectacular
economic performance. Inflation reduced from more than 3,000 percent in 1989 to 0.1 percent in
1996. Exports, GDP, investment and the federal deficit also performed very well (Table 1).

Table 1: Macroeconomic Performance
(average annual percentage)
1981-1990 1991-1998
GDP Growth -1.1 5.8
Investment Growth -7.6 14.6
Export Growth 4.4 7.9
Deficit as % of GDP 9.7 0.8
Inflation 386.6 2.7

Source: Kiguel 1999 as found in Canavese 2001

However, the currency board arrangement proved too strict and the exchange rate peg
overvalued. The situation was exacerbated when Brazil, one of Argentina’s major trading
partners, saw its currency devalue from 1.12 reals to the USD in 1998 to 3.88 reals to USD in
2002. In January-February 2002, the currency board and the peg were abandoned and replaced
by a free float. The peso depreciated from its peg rate of 1:1 with the USD to nearly 4:1. The
abandonment of the peg was part of a macroeconomic crisis that included a reduction in GDP of
28 percent from 1998-2002, an increase in inflation peaking at more than 40 percent in 2002 and
a doubling of unemployment from 12 percent in 1998 to 24 percent in 2002. In December 2001,
the central government froze bank accounts and deposit holders were allowed to use their
deposits to pay only other depositors in the same bank
3
.

The Issuance of Alternative Currencies

After the peso was allowed to float in February 2002, the central bank did not print a
sufficient amount of pesos to serve the country’s needs for fear of hyperinflation
4
. In response
the federal and provincial governments issued alternative currencies. The federal government
was required to make certain transfers to the provincial governments. In 2001, a minimum limit
to those transfers had been established by law. So, the federal government was required to
transfer a certain amount of funds to the provincial governments regardless of the amount of
revenues it collected. The crisis of 2001 led to a reduction of federal government revenues. The

1
The author is grateful to Lewis Solomon of The George Washington University Law School and Luis
Cubeddu of the International Monetary Fund for their support and contributions to this paper.
2
Canavese 2001.
3
Saxton 2003.
4
Recarte 2002.

2. Desilets – Argentina Article
2
federal government did not have enough funds to fulfill its legal obligations to transfer certain
amounts to the provinces. To make up the difference between available tax revenues and
required transfers, the federal government issued lecops. The lecops were issued as government
debt, thereby circumventing the central bank charter which gave the central bank sole authority
for issuing Argentina’s currency, though the lecops circulated as currency. During the crisis,
lecops represented approximately half of the alternative currencies issued in Argentina.

Provincial governments faced their own crises and issued their own currencies. As they
were receiving federal government transfers in the form of lecops, they decided to issue their own
currencies. The central government did nothing to stop the emission of provincial currencies or
spending by provincial governments
5
.

At the end of 2001, provincial currencies amounted to nearly 30 percent of pesos in
circulation and at the end of 2002 to nearly 50 percent of pesos in circulation, or USD2.7 billion
(USD2.3 billion in 1999 USD as show in Graphs 1-2).
6
Some estimate that the amount of
provincial currencies issued was as much as USD5 billion.
7

Graph 1: Pesos and Provincial Currencies in
Circulation, 1999-2005
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
12.0
13.0
14.0
15.0
1999 2000 2001 2002 2003 2004 2005
Billions of 1999 US$
Pesos in Circulation
Provincial Currencies









5
Recarte 2002.
6
IMF 2004, 2005.
7
Cibils, Kar and Weisbrot 2002.

3. Desilets – Argentina Article
3 Graph 2: Argentina Monetary Base, 1999-2005
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
12.0
13.0
14.0
15.0
16.0
17.0
18.0
1999200020012002200320042005
Billions of 1999 US$
Augmented Monetary Base (incl. provincial currencies)
Monetary Base


At the height of the crisis, more than 20 alternative currencies circulated in Argentina.
Their numbers and uses varied greatly. Some served the functions of full monies much more than
others by circulating widely throughout the country or highly populated provinces and by
entering the banking system in separately denominated accounts (Graph 3). Since the federal
government used lecops to transfer funds to provincial governments, lecops could be found in use
throughout the country. The patacon, issued by the province of Buenos Aires was used to pay
provincial and federal taxes and also could be found throughout the country. Banks established
accounts denominated in both patacons and lecops.

4. Desilets – Argentina Article
4 Graph 3: Deposits and Monetary Base in
Argentina, 1999-2005
0
5
10
15
20
25
30
35
40
45
50
55
60
65
70
75
80
1999 2000 2001 2002 2003 2004 2005
Blns. of 1999 US$
Augmented Monetary Base
Monetary Base
Foreign Currency Deposits
Total Deposits
Currency in Circulation

The alternative currencies generally traded at a discount to their face value and the
amount of the discount depended on the utility of the currency. Lecops and patacons traded at a
discount of only 5 percent whereas some other currencies traded at a much larger discount or not
at all. As with any currency, the value of these alternative currencies increased with their area of
use and their acceptance for payment.

Effects of the Alternative Currencies

It is possible that the alternative currencies contributed to inflation. From 2001-2002, the
same period in which alternative currency issuance ballooned, inflation increased from -1.5
percent to more than 40 percent
8
. However, much of this inflation was due to adjustments caused
by the revaluation of the peso from its peg of 1:1 with the USD to 4:1.

Some observers maintain that the fall in Argentina’s GDP would have been much greater
without the issuance of the alternative currencies
9
. The lack of liquidity in the economy could
have reduced economic activity and effected a much more severe contraction of the economy.
Certainly, the use of provincial currencies has some benefits over barter markets, 8,000 of which
opened in Argentina during the crisis
10
.

Alternative currencies were used to pay hundreds of thousands of public employees
11
and
local businesses accepted alternatives currencies as payment. Some observers believe that these
payments should not have been facilitated and that the issuance of alternative currencies was a

8
IMF 2004, 2005.
9
Cibils, Kar and Weisbrot 2002.
10
Recarte 2002.
11
Cibils, Kar and Weisbrot 2002.

5. Desilets – Argentina Article
5
disguised adjustment. The alternative currencies could be viewed as securitized arrears for public
employee salaries.

However, even with the issuance of the alternative currencies, Argentinians experienced
an adjustment. The price of imports increased and consumption suffered or adjusted
appropriately. The issuance of the alternative currencies allowed the domestic economy to
continue functioning. An employee of a provincial government still could buy lunch with some
percentage of his hourly earnings even if he couldn’t still buy himself a bottle of French wine for
the same amount as before the crisis.

Theoretical Framework

Kiyotaki and Wright (1993) use the example of red and blue money in their model but
here I will use the example of lecops and pesos. As in the original model, the two monies have
different yields, yL and yP. They also have different levels of money supply, ML and MP. The
proportion of traders with lecops and pesos are denoted L and P. L and P denote the
probabilities of random commodity traders accepting lecops and pesos. The flows of returns are
given by the following equations.


(1) rV0 = (V1 – V0)

(2) rV1 = Cx
2
(U –  +V0 – V1) + PxmaxPP (VP – V1) + LxmaxLL (VL – V1)

(3) rVP = yP + CxP(U –  +V0 – VP)

(4) rVL = yL + CxL(U –  +V0 – VL)

(5) L = x

where  = (r + Cx + P)/(r + Cx + Px)


The goal is to construct an equilibrium in which both monies circulate but with different
acceptabilities: 1 = P > L > 0. This requires VP > V1 = VL. The relation VP > V1 follows
immediately from 1 = P.

For the case in which yP = yL = 0, (2) – (4) imply that VL = V1 if and only if (5) holds.
Notice that  > 1. If P = 1 and L = x, we have an equilibrium in which pesos are universally
acceptable and lecops are partially acceptable.

I can construct an equilibrium in which yP < yL with 1 = P > L > 0. In this equilibrium,
both monies circulate, but the high-return asset is less acceptable or less liquid than the low-return
asset. Pesos are universally acceptable not because they have a higher return but because they are
more liquid. If the spread yL – yP becomes too big, however, this equilibrium can no longer exist.

I can determine the amount of lecops a trader would accept considering the conditions of
the crisis. During the crisis, the federal government issued lecops so they could pay their legally
required transfers to provincial governments. The federal government also accepted lecops for

6. Desilets – Argentina Article
6
tax payments. In addition, lecops helped to fill the liquidity gap left by the decision of the central
bank to not issue pesos. Given these functions of lecops, we can write the demand for lecops as:

(6) DL = tFY0 + (M
*
– MP) (VL/W)

In words, a trader’s demand for lecops equals his tax payments to the federal government
plus the liquidity shortfall in pesos. Traders would normally be willing to accept lecops only up
to the amount of taxes they owe to the federal government. However, because of the shortfall of
pesos, traders also would be willing to accept an additional amount of lecops equal to the peso
shortfall to complete transactions they are unable to complete with pesos. Presumably, they
would be able to use these additional lecops to purchase their own consumption goods from other
traders.

Next, I expand the Kiyotaki-Wright model to include additional alternative currencies
that were issued in Argentina during the crisis. I will use Cordoba as an example. During the
crisis, the provincial government of Cordoba issued its own currency, the cecor. In the model,
the flow of return to a cecor trader would be:

(7) rVCOR = yCOR + CxCOR(U –  +V0 – VCOR)

Since the provincial currencies traded at a discount after they were issued, we can assume
that yCOR < 0.

To determine the probability that a trader would accept cecors, I will make some changes
to the Kiyotaki-Wright model. Specifically, I will disaggregate the types of agents/consumers to
identify groups of consumers that consume certain sets of commodities. Let xCOR be the
proportion of Cordoban commodities consumed by agents in the province of Cordoba. I assume
that agents in Cordoba consume more of the goods made in Cordoba than the average agent so
are more likely to accept cecors, the money issued by Cordoba. The demand for cecors would
look something like this:

(8) DCOR = xCOR + (VCOR/W)(M
*
– MP – ML) + tPY1

In words, a Cordoban trader will accept cecors up to the amount of his own consumption
of Cordoban goods plus a portion of the shortfall of pesos and lecops equivalent to the portion of
his value in the overall economy plus the taxes he owes to the provincial government.

In the year following the issuance of the alternative currencies in Argentina, inflation
soared to 40 percent. One possible explanation for this inflation is the over-issuance of money
which flooded the economy and pushed prices up. In our model, we would assume that M > M
*
.
Since there was a reported shortage of pesos, I would have to assume that this excess money
supply must have come from the alternative currencies: lecops, cecors and the other provincial
and provisional monies. Next, I examine how M affects the price level in the model.

Kiyotaki and Wright tell me that M = C/P, assuming that each trader has P units of
money and all P units are required to purchase one commodity. If I make the same assumption, I
can say that P = C/M. Remember that M is the number of agents endowed with money. I assume
that the same agents are endowed with the new alternative currencies as with the original pesos.
So, MP + ML +…Mi = M. So, I can increase C without increasing M. If C = P + L + … i, then as
alternative currency issuance increases, so does P since M remains constant while C increases.
Spending by the provincial governments can be explained by:

7. Desilets – Argentina Article
7

(9) GP = tY + T + B

That is, provincial government consumption equals taxes plus transfers from the federal
government plus net borrowing. What I observe in Argentina is that, with the exception of
Buenos Aires, poorer and less indebted provinces issued quasi-currencies. So, I model the
amount of provincial currency issued as such:

(10) CP = –1 (z1Y + z2B + z3MP)

The amount of currency issued is a negative function of provincial income, provincial
borrowing and the supply of pesos, with the z’s as weights. There are at least two implications of
this equation. First, I want to examine the relationship of income and currency issuance. It is
possible that the poorer provinces were more peripheral to the Argentinian economy to begin
with. Perhaps they had less access to the money supply and to banking services and capital
markets. To test this, I would need to investigate the number of banks and the amount of loans
per capital by province. The provinces may have been less indebted because they had limited
access to banking services. Unfortunately, such as investigation is beyond the scope of this short
paper.

Second, it is possible that provinces that already were indebted would be limited in their
issuance of alternative currency because their debt had already been discounted or devalued.
From a central banking perspective, I would say that the credibility of the issuer may already
have been eroded. In this sense, the provinces that were not heavily indebted had credibility
reserves on which they could issue currencies in which their populations would have confidence.
To test this, I would need to determine if the less indebted provinces had balanced budgets that
would support the idea that their credibility was higher than the more indebted provinces. Such
an analysis is beyond the scope of this paper but is an opportunity for future research.

Comparative Experience with Alternative Currencies

In many ways, the alternative currencies of Argentina resemble the currencies issued by
new countries that separated from existing monetary unions after financial crises and economic
downturns. The crisis in Argentina is on a much smaller scale, but still a comparison is
enlightening. The countries of the former Soviet Union all issued their own currencies in
response to similar pressures. In 1992, Russia liberalized prices which then skyrocketed to meet
world levels, much as the rupture of the exchange rate in Argentina caused prices to adjust to real
levels. The central government in Moscow did not issue a sufficient number of rubles to cover
the price changes for fear of inflation, much the same as the central bank of Argentina failed to
issue sufficient pesos to keep up with price changes. In response, local governments throughout
the Soviet Union issued their own currencies to pay their workers and to facilitate local trade.
Many of the currencies of the former Soviet Union could be viewed as “quasi-monies” since most
of them are used only to a very limited degree for banking and savings (Table 2). And, perhaps
just like the alternative currencies of Argentina, one day the “quasi-monies” of the former Soviet
Union will be reined back into the ruble zone or disappear as those countries dollarize or euroize
completely.

8. Desilets – Argentina Article
8

Table 2: Foreign Currency Deposits as a
Percentage of Total Deposits, 2000-2006
Georgia 0.94
Armenia 0.75
Azerbaijan 0.59
Belarus 0.57
Tajikistan 0.57
Kazakstan 0.51
Moldova 0.50
Latvia 0.41
Lithuania 0.40
Russia 0.39
Ukraine 0.35
Estonia 0.30
Source: Table 4 from Basso, Calvo-Gonzalez
and Jurgilas 2007.

In this interpretation, the monetary union of Argentina (not to mention that between
Argentina and the US) ruptured. Independent currencies were issued by local governments and
the local governments enjoyed the benefits experienced by any money issuer: seignorage; the
achievement of adjustments through exchange rates rather than prices; support for local economic
activity and more appropriate monetary policy. The issuance of the provincial currencies
probably also affected trade in the same way the issuance of new national currencies has affected
trade, by reorienting trade inward and acting as a protectionist measure

One important distinction between the alternative currencies of Argentina and new
national currencies is the status of legal tender. Even at the provincial level, governments did not
require businesses to accept the alternative currencies for payment. Some businesses refused to
accept the alternative currencies. Some accepted them only to a certain extent (probably
equivalent to their tax bill to the provincial government plus the value of local inputs to their
businesses as indicated by the theoretical model above).

The alternative currencies of Argentina also are comparable to a variety of alternative
currencies used in the US from 1857-1913 that helped to temper the financial crises of 1884,
1893 and 1907. Beginning in 1871, the US Treasury began buying back US government debt.
The 1863 National Banking Act already required national banks to back up its currency issuance
with that same US government debt. The result of the Treasury buy-back program was a shortage
of currency issued by national banks. In response, banks issued clearinghouse notes in small
denominations to circulate as currency. The clearinghouses were private associations of banks
that ensured interbank payments. During this same period, reputable individuals and firms issued
their own checks in small denominations which also circulated as currency. Banks did the same
with cashiers’ checks and negotiable certificates. The issuance of these various alternative
currencies greatly reduced the damage of the various panics of the period
12
.





12
Solomon 1996.

9. Desilets – Argentina Article
9

Conclusion

As part of its assistance program for Argentina, the IMF required the central government
to enter into bilateral agreements with the provincial governments to stop the issuance of
alternative currencies. Throughout 2002, the Fund worked with the central government on the
framework of those agreements. Eventually, more than half of the provincial governments
entered into agreements requiring them to stop issuing alternative currencies.

Whether the alternative currencies were a form of disguised adjustment or an appropriate
response to the financial crisis, their issuance surely helped the local economy to continue
functioning, just as the issuance of new currencies did for the countries of the former Soviet
Union and just as alternative currencies did for the US during its financial crises in the period
1857-1913. The use and issuance of the alternative currencies was surely more efficient than the
use of barter markets which were common in Argentina during the crisis. On the other hand, the
supply of alternative currencies may have exceeded demand, thereby fueling inflation.

References

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