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Dollarization: An Irreversible Decision


After faithfully maintaining a fixed exchange rate and fully convertible currency for almost a decade Argentina still pays higher interest rates on peso denominated debt than on US dollar denominated debt. The interest rate spread is the price of keeping the option to devalue alive. Argentina has sufficient foreign reserves to defend the currency against any attack, but they could choose to devalue if the pain of maintaining the currency peg got too great. Investors fear devaluation and they charge Argentina for the option to devalue. In 1999 President Menem recommended "dollarizing" the economy. Dollarization extinguishes the option to devalue.

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