The problem with politicians, especially populists, is if they actually do what they had promised. On the senselessness of dollarisation in Argentina.
Matías Vernengo is Professor of Economics, Bucknell University (US) and formerly Senior Research Manager of the Central Bank of Argentina
Sergio Cesaratto is Professor of European monetary and fiscal policies, International Economics, and Growth and development at the University of Siena.
An Italian version of this piece will appear in Il Fatto quotidiano
Javier Milei will be the next president of Argentina. Milei is an extreme right-wing populist, with authoritarian, some may say Fascistic, tendencies. He is an admirer of Trump and Bolsonaro, and has affinities with many extreme right-wing leaders in Europe, including Giorgia Meloni. He is also very much against the Pope, to whom he has referred as “the representative of the Evil one on earth,” in particular for his criticism of the failures of free market capitalism. His party’s proposals range from the dangerous – like dollarization, the closing of the Central Bank, the drastic reduction of social spending, the loosening gun ownership laws, and the criminalization of abortions – to the insane – like instituting a market for human organs. Some of his views are outright authoritarian, like his direct criticism of democracy and his minimization of the human rights violations of the last dictatorship.
He has also has played fast and loose with all his proposals, suggesting that he may not do anything that he promised to do, at least during the campaign, with the exception of one. He has maintained that dollarization is not negotiable. The dangers of dollarization could not be minimized. Dollarization implies getting rid of the domestic currency, very much like joining the euro, and the elimination of the lira. It means essentially losing the ability to do independent economic policy. At least Italy maintained some feeble say in the ECB’s choices. Thw first limitation is, obviously, the loss of monetary policy. The treasury would issue debt in dollars, and the money supply would be limited to the dollars within the country. The central bank would not be able to control the quantity of money, the basic interest rate would be set by the Federal Reserve (Fed), and Argentine dollar denominated bonds would pay a risk premium on United States Treasury bonds. The Fed would not buy Argentine bonds in periods of distress, and interest rates would be higher. The standard objection is that once the risk of devaluation disappears, interest rates would fall. In the Italian experience this happened with the euro before 2008, but afterwards, without the ECB umbrella, rising spreads would have led Italy to default, or exit from the euro. This means that what Draghi in his most famous speech called the ‘redenomination risk’ of domestic currency bonds never really disappears for good.
The absence of a currency, again very much like in the case of the euro, would imply the impossibility of devaluing the currency to stimulate exports. In the case of more advanced economies that export manufacturing goods, like Italy, that is a serious implication of abandoning the domestic currency. In the case of Argentina, that has deindustrialized over the last five decades, and that is mostly an exporter of commodities like soybeans, the impact on manufacturing and exports is more limited. Exports depend mostly on the growth of the world economy, in particular China, the main buyer of Argentine commodities.
Perhaps more importantly the abandonment of the peso would imply giving up, to a great extent, fiscal policy, the ability of the government to manage its budget and the national debt. In most developing countries, Argentina included, fiscal policy is always restricted by the balance of payments. The government cannot spend and increase output and income, that increases imports, beyond the ability to borrow in foreign currency. In other words, if the economy and its needs of foreign currency grow beyond the rate of growth of net exports there would be an external crisis. But dollarization exacerbates the problem. All debt would be in a foreign currency. Debt in foreign currency can only be repaid with the dollars obtained from exporting, which would limit drastically the ability of the government to borrow at reasonable rates, in particular since Argentina is already deeply indebted with the International Monetary Fund (IMF) and private creditors. The central bank will not be able to buy bonds, and keep interest rates on public debt relatively low, something that, contrary to what most people think and orthodox economists decry, is a typical function of central banks. The Federal Reserve did that during the Great Depression, and again after the Great Recession of 2008 and the Pandemic. But the Fed will not buy Argentine bonds.
Dollarization, like the euro, would impose a harsher limitation on the ability of the Argentine economy to grow. This should be seen as similar to the harsh adjustment imposed by the Troika on Southern European countries after the euro crisis. Greece, that has a GDP still more than 20 percent below its peak, before the crisis, is a cautionary tale for Argentina.
Of course, for neoliberal economists, like Milei, a self-declared Austrian economist, the idea is to dollarize to stop inflation, which is running at almost 140 percent annually. Note that inflation is not caused by the central bank and the printing of pesos. Inflation results from the persistent depreciation of the peso, caused by the lack of dollars, and wage resistance. A depreciated peso reduces the purchasing power of wages, since a depreciation increases the prices of imported goods that go into the production of other goods. As workers can buy fewer goods, they demand higher wages. An increase in wages is passed to prices, fueling the distributive conflict. Dollarization resolves the problem by essentially precluding any depreciation of the currency. However, to dollarize Milei would need to obtain, preliminary, large amounts of dollars to ensure the functioning of the economy and the banking system. But if the dollars were obtained, the central bank could intervene in the foreign exchange rate market, stabilize the peso and stop inflation. In other words, dollarization is only possible in a context in which it is not needed anymore.
The real reason for dollarization, and why it does have the support of Argentine elites, is associated to the desire to promote a radical reduction of real wages in dollars. In fact, Milei has openly said that the more the peso depreciates before dollarization the better. In other words, it intends to encourage a strong devaluation of the peso, so as to reduce the value of wages in dollars, and then dollarise. He would cause the whole economy to collapse in order to stabilize it. He would cure the disease, but kill the patient.