CURRENCY BOARDS FOR DEVELOPING COUNTRIES A HANDBOOK (REVISED E

CURRENCY BOARDS

FOR DEVELOPING COUNTRIES:

A HANDBOOK

(REVISED EDITION, 2015)

by Steve H. Hanke and Kurt Schuler

The original version of this study was published by ICS Press, San Francisco, in 1994 for the International

Center for Economic Growth. It is copyrighted 1994 by the Institute for Contemporary Studies. This

revised version is issued with the permission of the International Center for Economic Growth. All rights

reserved by the International Center for Economic Growth for the original edition and by the authors for

additions.

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In the beginning God created sterling and the franc.

On the second day He created the currency board and, Lo, money was well managed.

On the third day God decided that man should have free will and so He created the budget deficit.

On the fourth day, however, God looked upon His work and was dissatisfied. It was not enough.

So, on the fifth day God created the central bank to validate the sins of man.

On the sixth day God completed His work by creating man and giving him dominion over all God's

creatures.

Then, while God rested on the seventh day, man created inflation and the balance-of-payments

problem.

¡ªPeter B. Kenen (1978: 13)

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CONTENTS

Preface to this version¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­vi

About the authors¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­..vii

1. The case for currency boards¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­1

Currency board versus central bank

Currency boards versus dollarization, multinational central banks, and free banking

Currency boards and wider economic reforms

Outline of this study

2. The case against typical central banks¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­13

The functions of money

Stability and credibility

Credibility and exchange rates

Convertibility and foreign-exchange controls

Central banking and deficit finance

Political independence: an unattainable goal

Inadequate staff

Flexibility: a problem even in theory

3. Currency boards, central banks, and the money supply¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­26

Money supply in a currency board system

Money supply in a central banking system

Central banks sometimes mistaken for currency boards

A brief history and assessment of currency boards

Currency boards and currency board-like systems today

4. How to establish a currency board¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­45

How to convert a central bank into a currency board

The alternative: a parallel currency approach

How to establish the currency board as the issuer of a parallel currency

How to choose a reserve currency

How to calculate the initial foreign reserves

How to obtain the initial foreign reserves

5. How to operate and protect a currency board¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­.56

How to operate a currency board

How to protect a currency board

How to change the reserve currency, if necessary

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6. Objections to currency boards¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­.63

No lender of last resort

Does size matter?

Fixed versus floating exchange rates

Deflation

The inflation tax

The cost of reserves

Colonialism

The worst case

7. Conclusion¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­72

Appendix: A model currency board constitution¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­.74

Selected Bibliography¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­¡­.77

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Figures

Figure 1.1. A typical currency board versus a typical central bank

Figure 3.1. Balance sheets

Figure 3.2. Money supply increase in a currency board system

Figure 3.3. Money supply increase in a currency board system, initial stage

Figure 3.4. Money supply increase in a currency board system, intermediate stage

Figure 3.5. Money supply increase in a currency board system, final stage

Figure 3.6. Money supply decrease in a currency board system

Figure 3.7. Money supply decrease in a currency board system, initial stage

Figure 3.8. Money supply decrease in a currency board system, intermediate stage

Figure 3.9. Money supply decrease in a currency board system, final stage

Figure 3.10. Money supply increase in a central banking system with a floating exchange rate

Figure 3.11. Money supply decrease in a central banking system with a floating exchange rate

Figure 3.12. Central bank and currency board balance sheets

Figure 3.13. Currency boards today and in the recent past

Figure 7.1. Summary of proposals

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