History offers Argentina a cautionary tale on dollarisation

[Judi Lynn]

Estimated reading time: 5 minutes

Bert van Stiphout-Kramer
Petros Milionis
April 10th, 2024

Argentina’s president, Javier Milei, has promised to dollarise the economy and eliminate the central bank to deal with the country’s fiscal crisis and runaway inflation. Bert van Stiphout-Kramer and Petros Milionis look at the theoretical and historical difficulties of transitioning to a rigid monetary regime and recommend careful consideration of both its economic and political implications before any decision is made.

The recent presidential election in Argentina and the unexpected victory of libertarian economist Javier Milei have generated renewed interest in the country’s economic malaise. Argentina has been dealing with soaring inflation rates and an unabating fiscal crisis for several years. Milei has promised to tackle both with a series of radical reforms.

Most prominent among these is a proposal to dismantle the country’s central bank and to replace the Argentinian peso with the US dollar. He claims that doing so will eliminate the ability of the government to monetise fiscal deficits and put an end to triple-digit inflation rates. These claims invoke the experiences of Ecuador, El Salvador and Panama, all of which have already dollarised. Given the much larger size of the Argentinian economy, though, this raises the questions how likely the prospects of an Argentinian dollarisation are and how viable this policy will prove. On these two questions the monetary history of Argentina provides a cautionary tale.

Among all radical economic ideas proposed by Milei during his election campaign, the dollarisation policy generated the most discussion and debate among Argentinians as well as foreign commentators. In a televised debate before the second round of the presidential election, this policy was one of the first lines of attack by his opponent, Sergio Massa, and one of the policy proposals that Milei was most eager to defend. Among libertarian economists the dollarisation policy has been lauded as a bold and effective move to bring down inflation. More left-leaning economists, however, have dismissed it as an ineffective and potentially risky policy choice, which could hurt the more vulnerable socio-economic classes.

Leaving aside questions about the effectiveness of the policy in the long run, some scholars have also raised doubts about the ability of the government to manage the transition process. A key problem would be the lack of dollar reserves by the central bank, which may further fuel inflation before and immediately after a decision to dollarise the economy. Moreover, the introduction of a foreign currency as legal tender implies the end of independent monetary policy, and the closure of the central bank implies the loss of a lender of last resort. This will severely limit the ability of the Argentinian government to weather macroeconomic shocks and is expected to have a negative impact on economic growth.

More:
https://blogs.lse.ac.uk/businessreview/2024/04/10/history-offers-argentina-a-cautionary-tale-on-dollarisation/

[peppertree]

1. True. Dollarization would lock in the current "Mileise" - i.e. a full-on depression - for years to come.

Argentina - a middling-resource country - can't earn anywhere near enough dollars to sustain a healthy economy constrained by the sole use of dollars.

Even Ecuador - an oil-rich country with much smaller import needs - has struggled mightily with its dollarization. And now that oil exports can't earn what they used to, relative to its import needs, it's collapsed outright.

And a big part of that cost is the "prep work" - i.e. depressing the economy beforehand to the point that, in Argentina's case, the 50 trillion pesos in circulation (mostly business deposits) would dwindle down to a "manageable" amount to compensate in dollars when dollarization is in fact imposed (assuming it ever is).

But without the kind of massive export earning Argentina would need to meet all its obligations (debt, outbound travel, etc.) and finance a healthy economy (and all its import needs) in a dollarized context, the result would be a long-term depression.

A "Mileise" - if you will.

Thanks as always, Judi, for keeping up with the bedlam in Buenos Aires. Have a great weekend!