28 November 2023

Milei’s dollarisation plan isn’t as crazy as it sounds


With his crazy hair, cloned dogs named after famous economists, and a penchant for wielding a chainsaw on the TV, Argentina’s President-Elect Javier Milei is certainly an unconventional politician. It’s not just his personality that has raised a few eyebrows either. His policies have caused a great deal of controversy, not least his plan to close down Argentina’s central bank and adopt the US dollar as the official currency.

While this policy is certainly extreme, dollarisation – if enacted alongside other reforms – has the potential to put an end to Argentina’s extremely high inflation and bring about sustainable economic growth.

Milei’s economics would probably be best described as Austrian School. That is why he wants to get rid of Argentina’s central bank. I personally think that there are lots of flaws with the Austrian School, and that independent central banks are actually a very good thing. Central banks can inject much needed capital into an economy and help to stave off a recession and it is preferable to have monetary policy controlled by independent technocrats rather than meddling politicians. In normal circumstances every country should have an independent central bank.

However, Argentina is not normal. As the great economist Simon Kuznets once said, ‘There are four types of countries in the world: developed, underdeveloped, Japan, and Argentina’. The economy of Argentina continues to confound economists. Despite once being one of the wealthiest nations on Earth, it is now an economic basket case which experiences endless cycles of borrowing, money printing, high inflation, and default due to the failed policies of its politicians – and it is the ordinary people who see their livelihoods destroyed. There is nothing normal about Argentina’s economy.

Moreover, an independent central bank only works if it is actually independent and run by competent officials. This is hardly the case with Banco Central de la República Argentina. It has enabled successive governments in their profligacy by excessive money printing which has led to inflation of over 142%. 

Dollarisation is perhaps the only thing which can help to put an end to Argentina’s rampant inflation. Milton Friedman wasn’t quite right when he said that inflation is always and everywhere a monetary phenomenon. However, he was spot on with Argentina. The central bank has printed so much money that the peso has been completely debased. Replacing it with the much more valuable US dollar would help to put an end to this and get inflation back under control.

This is not just economic theory – the experience of other countries show that this can work. El Salvador, Ecuador, and Panama which have all dollarised and Peru which has semi-dollarised all have the lowest inflation in the region, and the fully dollarised nations have seen their GDP per capita surpass that of Argentina in recent years.

Of course, dollarisation itself will not bring about growth in Argentina, but it will certainly help. Not only will it put an end to high inflation, it will send an important signal to investors. Right now investing in Argentina is not an attractive option due to the incredibly high inflation and other problems blighting the economy. What is more, Argentina is a very risky proposition for lenders. The government has a dreadful track record of trying to inflate its debt away before eventually defaulting and being bailed out by the IMF. Right now there is no evidence for investors or lenders that Argentina won’t simply promise to change its ways, get some money, and then resume the cycle of money printing, high inflation, and default. Dollarisation means that this can no longer happen. It would mean that politicians could no longer exert any control or influence over monetary policy because those decisions would instead be made over 5,000 miles away by the Federal Reserve in Washington DC. Try as they might, under dollarization the Argentinian government can beg and plead for the money printer to be turned back on, but Jay Powell is unlikely to be moved. 

Dollarisation also makes sense as it would simply be making what is already going on official. Lots of everyday transactions are already conducted in dollars instead of pesos. What is more, the majority of international trade is conducted in dollars as well. 

It has been argued that Argentina cannot dollarise as its central bank does not have sufficient dollar reserves. While it is true that the central bank is short on dollars, the people of Argentina are not. Argentines hold over $246bn either in foreign bank accounts or stashed away somewhere safe. This amounts to over 50% of Argentina’s GDP. The Argentine economy has many problems, but a shortage of dollars is not one of them. At the moment, encouraging people to deposit their dollars in their domestic bank accounts is a difficult sell, but the very fact that the government is prepared to dollarise sends a powerful signal to ordinary Argentines that their money is safe in the country.

It also needn’t be that difficult to achieve. The Argentine economists Emilio Ocampo and Nicolás Cachanosky have set out how it would work. In short, there are three separate groups of peso-denominated liabilities which would need to be dollarised. The first are bank deposits which are the most straightforward of the three and can be dollarised immediately. The second is the currency already in circulation. This would involve a more phased approach and so take slightly longer. The third are the central bank’s liabilities which would take much longer and would be more complicated to dollarise.

Of course, dollarisation is not the sole solution to Argentina’s economic malaise. It will need sweeping reforms of its entire economy, such as privatising industries and cutting public spending (while also protecting the incomes of the most vulnerable). It will also need to look at international trade. Given that it is a member of Mercosur it applies the Common External Tariff, which makes it difficult for it to become more open to imports. However, it recently agreed to eliminate tariffs on food entering the country, so there is some latitude in this area. The new government should commit to ending the sky high subsidies it hands out to many industries and impose some export discipline. Not only will this help to make Argentine firms more competitive and profitable, it will also increase the supply of dollars in the country.

Dollarisation is an extreme move and is not without risks. However, the people of Argentina have suffered for decades under the failed economic policies of successive governments. There is an old saying, ‘As rich as an Argentine’. Dollarisation – alongside other economic reforms – has the potential to make this true once more. 

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Ben Ramanauskas is Research Fellow at Oxford University.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.