Currency Competition and Bi-Monetarism: Some Important Differences
In recent days, expectations have risen that Javier Milei's government aims to implement what they call a regime of currency competition. The recent staff report from the International Monetary Fund (IMF) increased these expectations. Yet, it is important to distinguish between a proper currency competition regime and bi-monetary regimes. Additionally, some particular characteristics of Milei’s envision of currency competition are also relevant
The regime of currency competition, at least as used by the Argentine government, refers to two works by Hayek: Choice in Currency (1976) and Denationalization of Money (1978). Hayek was not the only one to address this monetary regime. For instance, Klein (1974, 1975) and Nash (2002) explore similar ideas. Under this monetary regime, various currencies compete on equal terms. Hayek imagines that (private) issuing banks issue fiat money (i.e., non-convertible bills). These issuing banks compete with each other by maintaining the purchasing power of their money stable. Hayek also envisions that some banks might specialize in specific markets, issuing currency that maintains its purchasing power stable over goods traded in specific markets (energy, agriculture, etc.).
Currency competition is not without problems. In theoretical terms, White (1999, ch. 12), and also Klein, highlight a potential problem of time inconsistency. An issuing bank might be tempted to over-issue its money and buy other financial assets before the bank loses its customers. Unlike a free banking regime, Hayek-style banks do not have a contractual obligation to their clients regarding the purchasing power of the money; they only have the promise to keep it stable. In a free banking regime, issuing banks have a contractual obligation to convert their bills into another asset (e.g., gold), so this problem does not exist.
In empirical terms, Friedman suggests that Hayek forgot to consider the network effects present in money. Friedman doubts that, in a regime of currency competition, more than a handful of currencies would be seen competing with each other. Luther and White (2015) study this hypothesis and find that the market does not move from a bad to a good currency, given the "network" benefit present in the bad currency.
A bi-monetary regime has certain similarities with a regime of currency competition, but the differences are more important than the similarities. In a bi-monetary regime, two (or more) currencies circulate next to each other. In this sense, a bi-monetary regime is similar to currency competition. However, the fact that more than one currency circulates alongside the local currency does not mean that they compete on equal terms, so it is not currency competition properly understood. Bi-monetarism is acknowledged in the IMF staff report itself (footnote 15, p. 18, italics added), which confirms that other “currencies would not have legal tender status, and tax payments will continue to be made in pesos.” The staff report describes a bi-monetary regime, which it inaccurately calls currency competition (Milei’s government seems to fall into the same inaccuracy).
How does one move from a bi-monetary regime to one of currency competition? How can the dollar and the peso compete on equal terms? It is necessary to give the dollar the same legal status as the peso: legal tender (which requires a law from Congress). In a country with the institutional anomie of Argentina, this distinction is not minor. In countries with a higher level of institutional quality, such as Peru, Colombia, or Uruguay, bi-monetarism can be assumed to be a stable and credible regime. This is not the case for Argentina.
There is another important issue to mention. LLA (La Libertad Avanza) would be considering imposing some version of a 100-percent reserve requirement on bank deposits. There are different 100-percent reserve banking regimes, and even with Milei's statements, it is not entirely clear what his regime looks like or how would it be implemented. Additionally, the government seeks a law that prohibits the central bank from directly financing the Treasury.
Since the election campaign, three monetary regimes have been discussed:
Stable: De jure dollarization (which is compatible with currency competition)
Less stable: Currency competition without dollarization
Unstable: Bi-Monetarism
Lastly, it is important to distinguish between a bi-monetary economy and a bi-monetary regime. Argentina is a bi-monetary economy without a bi-monetary regime (a proper legal framework). There is a great diversity of bi-monetary regimes, such as the convertibility Argentina experienced during the 1990s. Just one bi-monetary experiment among several that shows that in Argentina, bi-monetarism is unstable.
The distinction between a patch and a solution is fundamental. A bi-monetary regime may work under the LLA government. But it is not consistent with Argentine history to assume that it will last in the long term (a patch). It could be argued that the country is in this monetary mess precisely because it started with an unstable bi-monetary regime given the country's institutional anomie. A long-term solution, robust enough to survive the new populist governments that Argentina will have in the not-too-distant future, is different (a solution). Dollarization remains the monetary regime most likely to survive Argentina's political volatility, and therefore it is the monetary regime with the best chance of finally putting the Argentine economy on the right track for future generations.