François R. Velde | Macro Paper Warehouse

Dollarization in Argentina

Written shortly after Argentina’s government publicly floated the idea of abandoning the peso for the U.S. dollar, this Chicago Fed piece uses Argentina’s 1991-99 currency-board experience – already “quite close to being fully dollarized” – as a test case for the broader debate over monetary anchors: fixed versus flexible exchange rates internationally, and rules versus discretion domestically, of which “dollarization is the ultimate rule.” The authors first document how the 1991 convertibility law ended Argentina’s chronic hyperinflation (78 percent per month at its worst) by pegging the peso to the dollar under a currency board requiring the central bank to hold reserves equal to at least 100 percent of the monetary base, and how this stabilization coincided with faster growth, though the peg has twice come under speculative pressure – the 1995 “Tequila” crisis following Mexico’s devaluation, and the 1998-99 “Vodka-Caipirinha” turmoil following Russia’s default and Brazil’s devaluation. They then work through the mechanics of unilateral and bilateral dollarization, calculating that Argentina would permanently forgo seigniorage income worth roughly 0.2 percent of GDP annually – income that would instead accrue to the United States – while gaining a stronger commitment device than a currency board, since a currency board still leaves scope for a government to reintroduce discretion (via emergency decree or a change in law) that a full currency abolition would foreclose. The paper argues most of the commonly raised objections to dollarization – loss of a lender of last resort, loss of monetary policy independence – are less decisive than they first appear, given mechanisms Argentina has already built to substitute for both, and it closes with a rough cost-benefit calculation suggesting dollarization would be worthwhile if crises resembling the Tequila effect (a roughly 14 percent permanent output loss) recur with even modest probability. The authors are explicit, however, that they “do not reach a definite answer on whether Argentina should dollarize,” and caution that abandoning even the possibility of an independent monetary policy is a serious and irreversible step.

Government Equity and Money: John Law's System in 1720 France

John Law’s “System,” carried out in France between 1716 and 1720, restructured French public finance around two linked innovations: converting most of the existing government debt into equity in a single, government-chartered trading and tax-collecting company, and replacing silver coin with paper bank notes as the primary medium of exchange. Velde traces the System’s four stages – the 1716 General Bank, whose notes gained acceptance partly because they were protected against the recurrent devaluations of the silver coinage; the 1717-1719 Company of the West, which grew by acquiring the tobacco monopoly, the General Farms tax-collection lease, the direct-tax collection offices, and the royal mints; the 1719-1720 merger of Bank and Company, in which the Company took over the entire national debt in exchange for its shares and its notes became sole legal tender; and the 1720 collapse and multi-year “Visa” liquidation that followed. Velde argues the System’s viability depended on convincing bondholders to convert voluntarily by keeping the Company’s share price high, and estimates, from the Company’s own disclosed revenue projections compared with post-System market valuations, that shares were overvalued at their January 1720 peak by a factor of roughly two to five; sustaining that price required an escalating volume of bank notes, which by spring 1720 was outrunning the demand for money and forced a sequence of increasingly coercive and self-contradictory monetary measures. Once Law’s price-support operations proved unsustainable in the spring of 1720, note issue could not be reversed in an orderly way, and the System unwound through a formal liquidation, the Visa, that converted the remaining notes, shares, and company bonds back into ordinary government annuities. The paper’s central quantitative finding is that, despite the scale and drama of the episode, France’s public debt in the mid-1720s stood at roughly the same level as in 1717, so that – unlike most French sovereign-debt episodes of the era – Law’s System was not, in net terms, a default.

Macroeconomic Features of the French Revolution

This paper interprets the French Revolution “from the vantage point of macroeconomic theories about government budget constraints” (p. 474), using two macroeconomic ideas – unpleasant arithmetic and sustainable plans – and three successive models of money as lenses on the same chronology of events. From 1688 to 1788, Britain reformed its institutions to smooth taxes and finance war debt while France defaulted repeatedly, and this asymmetry in “fiscal technology,” not any lack of arithmetic competence among French ministers, produced the fiscal crisis of 1788 that forced Louis XVI to convene the Estates General. The National Assembly’s response – confiscating church lands and issuing assignats redeemable at land auctions – created a “tax-backed money” scheme that functioned much as a real-bills or asset-backed theory of currency would predict: real balances of assignats grew and prices rose only moderately from 1790 through mid-1792. The war that began in April 1792 forced the government to divorce note issues from land sales, converting the tax-backed scheme into a fiat-money scheme whose depreciation accelerated sharply and threatened the inflation-tax base the government depended on. The Jacobins met this threat with a “guillotine-backed currency” of price controls and legal restrictions criminalizing refusal of the assignat at par, a policy episode the paper interprets through legal-restrictions models of currency demand: real balances rose and prices fell even as the government raised immense new issues to finance the war. When military victory removed the rationale for the Terror’s repressive apparatus in mid-1794, the legal restrictions became unenforceable and were abandoned, and the assignat entered a classical Cagan-style hyperinflation in 1795-96 in which real balances collapsed and prices exploded, ending in France’s 1797 default on two-thirds of its debt and a return to a specie standard. Throughout, the authors emphasize that these are not merely their own retrospective interpretations: the revolutionaries themselves debated the same theoretical questions – about backing, forced currency, and the inflationary consequences of deficit monetization – while designing and defending each successive monetary regime.