(FORTUNE Magazine) – Strong currency pegs used to mean one thing to Argentina: Adios, inflation. By linking its peso to the U.S. dollar at a one-to-one rate in 1991, Argentina tamed a grotesque inflation rate--which fell from quadruple digits in 1991 to less than 5% by 1994--and secured seven years of economic health. Now Argentina's economy is reeling again. Inflation is still low, but so are taxes, wages, bank deposits, growth, and employment.

Argentina's troubles have raised questions about the wisdom of strong pegs. In Hong Kong, which has had a strong peg to the U.S. dollar since 1983, Financial Secretary Antony Leung has twice mused aloud about the costs of maintaining it, noting that the peg makes the economy less efficient and flexible.

So should strong pegs be considered "voodoo economics"? Not quite, but like voodoo, they can do a lot of harm in the wrong hands. As Nobel economist Robert Mundell has pointed out, any country can have two of three things at the same time--exchange-rate stability, monetary control, or capital mobility--but not all three. Argentina's strong peg gave it currency stability when that was paramount, but now, as the country enters its 41st month of recession, it needs growth most of all, and its overvalued exchange rate is making that more difficult to achieve. With the peso uncompetitive against Brazil's real (which slipped its own peg in 1999), investment is fleeing.

There are two lessons here. First, while a currency peg can establish an environment for growth, it is not economic policy in itself. In Argentina the peg was like triage; it took care of the most urgent wound--inflation--but not the problems that led to it in the first place. Economies with fixed exchange rates need to have sound fiscal policies and flexible labor and asset markets to absorb external shocks. Argentina lacks them.

Second, a peg is only as strong as the government's credibility. Even though Argentina's top leaders keep insisting they won't devalue, their actions tell another story. In April, a cheaper "trading peso" was introduced for importers and exporters, a move that looked like devaluation by another name. And some provinces have begun issuing transferable IOUs in lieu of wages, in effect expanding the money supply, which is exactly what a peg is supposed to prevent. The peg is becoming less credible--and thus more vulnerable to speculation--by the hour.

This does not mean that currency pegs should be written out of the world economic script. A strong peg works well when it stabilizes cross-border investment ties, argues Jeff Frieden of Harvard. (That is why the Dutch guilder-German mark peg, for example, or that of small Caribbean states to the U.S., have worked without a hitch.) And Hong Kong's strong peg has been a key to maintaining consumer confidence and its standing as a financial center; the link has its issues, but the alternatives would be much, much worse.

Argentina's mistake was not that it adopted a strong peg but that it didn't manage a graceful exit. Mexico and Chile have ditched their pegs in favor of inflation targeting and floating rates. Argentina should have been heading there as well. Now it's likely to be forced off the peg, and the shock to the economy in the form of deflation, bankruptcies, and foreclosures will be brutal. The lesson for Hong Kong: Pegs can be strong, but they are not necessarily immortal.