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In an economics textbook, Modern Principles of Economics, the authors, Tyler Cowen and Alex Tabarrok, write that "The Argentine government did not have enough U.S. dollars to keep up the value of the peg,"(referring to the 1991 peg) almost suggesting that had they had enough US dollars that the peg would be kept. How does having more US dollars keep the value of the peso up?

If the exchange rate of the Peso was dropping due to decreased demand(people were converting pesos to dollars), shouldn't the government buy a non-USD currency with pesos to reduce the supply and push the price up, keeping the peg intact. How does having "enough" US dollars solve that problem?

Clearly, looking at this from just one perspective, the exchange rate, is limiting in itself, but the sentence seems to suggests it was a possibility. I would appreciate it if anyone could explain the authors rationale.

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For the central bank to decrease the currency supply and raise the value of the Peso they need something to buy up the currency with. They can't simply ask for donations of Pesos, they have to buy pesos using another currency which holds real value. The US dollar is generally the standard when it comes to those types of interactions, in the case of the Argentina the central bank simply didn't have enough dollars to buy pesos decreasing the money supply.

The other important point is that if I as an Argentinian citizen know I can exchange my peso for a US dollar at the pegged ratio I will be more confident that the Peso is worth the pegged rate in dollars. If the central bank is unable to exchange my currency at the pegged exchange rate I am unlikely to trust that exchange rate which devalues the Peso below the pegged rate.

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  • $\begingroup$ You make it seem like they wanted to lower the US to Peso exchange rate by decreasing USD supply which is senseless because of the sheer size otherwise I don't see how buying more Pesos decreases the currency supply. $\endgroup$ – user29568 Aug 29 '16 at 18:31
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    $\begingroup$ So lets say I'm the central bank. There are 1000 Pesos in the economy in circulation. Using U.S Dollars I buy up 200 pesos. There are now only 800 Pesos in the economy and 200 pesos held by the central bank not in circulation. The money supply of pesos in circulation has decreased. $\endgroup$ – TheSaint321 Aug 29 '16 at 18:49
  • $\begingroup$ Thanks! Isn't another option to buy pesos with a non-USD currency? Wont it achieve the same effect? $\endgroup$ – user29568 Aug 29 '16 at 19:02
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    $\begingroup$ It would although the U.S currency is generally the standard for transactions such as these because it is so well backed, stable, and generally easy to acquire internationally. $\endgroup$ – TheSaint321 Aug 29 '16 at 19:15
  • $\begingroup$ Thanks, perfect answer; it weird that I didnt see it that way. $\endgroup$ – user29568 Aug 29 '16 at 19:33
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Simply having more dollars may have served two purposes. Firstly, more dollars would mean that the central bank could have bought more pesos and exerted some upward pressure on the exchange rate. Secondly, fixed exchange rates can fall because of expectations about the central bank's credibility to its peg. If the prevailing expectation is that the central bank does not have the resources (reserves) or the will to defend the peg, pesos will begin to be sold en masse in the expectation of a devaluation.

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  • $\begingroup$ So, in effect, buying more pesos would raise the demand for pesos as well as the exchange rate. Surely, affecting the supply is far easier so why wasn't that an option; it could also bolster the credibility of the bank. $\endgroup$ – user29568 Aug 25 '16 at 19:20
  • $\begingroup$ They did not have enough US dollars to buy those Pesos and to maintain the peg $\endgroup$ – securitydude5 Mar 12 '18 at 14:20

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