Author: Davit Shatakishvili, Contributing Analyst, American University, Washington D.C.
A century ago, Argentina stood among the world’s wealthiest nations, positioned as a formidable economic rival to the United States. From the 1920s, over the next five decades, it developed into one of the world’s fastest-growing economies, characterized by business-oriented government policies and high wages. Argentina also became the main attraction center for global investment and migration flows. However, the resource-rich country that was perceived as the superpower of the future has, in the past few decades, turned into an economy that isstruggling to survive. Annual inflation in the country has reached 140%, and the poverty level is 40%, accompanied by a sharply devalued national currency and a financial debt of 43 billion USD to the International Monetary Fund.
As a result of the elections held in Argentina in November 2023, the country elected a new president, one distinguished by far-right, libertarian views – Javier Milei, who pledged bold and radical measures to address the country’s economic challenges. His election can be perceived as a form of protest against the country’s failing economy and monetary policy. One of Milei’s main promises is the dollarization of the country’s economy and the abolition of the National Bank. It is interesting, then, to discuss the economic effects of dollarization and its possible impact on the Argentine economy, based on the existing experience.
Economic Vision of the New President
At first glance, Argentina’s economy does not look too bad compared to other South American countries. Last year, its GDP per capita was13,700 USD (for comparison, in 2023, the GDP per capita in Chile was 17,200, in Brazil 10,400, in El Salvador 5,800, and in Uruguay 21,600 USD). However, if we compare it with European and Asian countries, Argentina lags significantly behind. Argentina’s main problem is inflation, which reached 143% in October last year, the highest level for the country in the last three decades. Consequently, the Argentine peso is one of the world’s weakest currencies. In general, Argentina’s economy can be classed as unstable, having gone through two recessions and hyperinflationary periods in the last 30 years. Partly, this was due to the fact that, for years, Argentina was forced to print money to offset government spending, leading to inflation. As a consequence, the country became less appealing to international investors. Experts argue that the challenging economic conditions were the decisive factor for Argentine voters, leading them to elect Javier Milei, a proponent of radical solutions, as president.
Javier Milei is the first elected president to call himself an anarcho-capitalist in the history of Argentina. According to him, the country is now in a deep crisis, to overcome which radical solutions are needed, and thus he announced his plan for “shock therapy”.
One of his first decisions was to devalue the peso by more than 50%. Accordingly, a fixed peso exchange rate was established, which increased from 366 to 800 pesos. Since 2019, Argentina has been artificially strengthening the peso through strict currency controls, increasing the demand for dollars on the black market. The above step aimed to encourage producers and exporters, as, with a devalued national currency, exporters have the opportunity to earn more by selling the same amount of products. Further, the new administration has introduced temporary taxes on certain types of exports and imports, although they say they will remove the taxes once this peak period passes. Under the Milei administration, the state will reduce its total workforce by about a third, halve the number of ministries to nine, and cut secretariats from 106 to 54. In addition, government spending will be significantly reduced, which includes the reduction of oil and transport subsidies. However, Javier Milei’s most important pre-election economic promise is the dollarization of the country and the abolition of the National Bank. He attributes inflation and the devaluation of the national currency to this institution.
Dollarization of the Argentina Economy
Dollarizing an economy does not necessarily mean it will begin to use dollars, but is rather a process in which the state uses foreign currency as its main monetary means of internal circulation. Many countries in the world have accumulated experience in this regard. For example, Italy, Spain and Greece dollarized their economies by introducing the euro. Following on from the 1990s, when these countries began to switch to the euro payment system, the rate of inflation decreased dramatically, and even equaled the rate of Germany. The same thing happened in South American countries, El Salvador and Ecuador. When they dollarized their economies, inflation dropped significantly, and nearly equaled that of the United States. It is likely that dollarization would reduce the rate of inflation in Argentina, too, and it is interesting to look into how much it would affect economic growth and the country’s resistance to shocks. Reducing inflation is also logical, as the country would no longer need to print new banknotes, a commonly identified primary source of inflation.
Proponents of dollarization of the Argentine economy predict economic growth in two directions. First, they say, dollarization will help reduce inflation, which in turn will increase investors’ confidence in the country’s economy. Second, dollarization will abolish the state’s ability to protect the national currency, such as through capital and monetary restrictions, which in turn will increase the volume of investments and trade turnover. European countries which have dollarized have seen their monetary policy rates significantly reduce and the volume of investments increase. The same thing happened in the cases of Ecuador and El Salvador.
As far as economic growth is concerned, the rate of growth in the same countries has slowed, and in some cases there has been a recession. Several important empirical studies have also confirmed that, on average, countries with dollarized economies show a slower and more vulnerable rate of economic development, but also have lower inflation than non-dollarized countries. Along with this, countries with fully dollarized economies are characterized by a slower growth rate than non-dollarized and partially dollarized countries.
In general, the majority of economists are against dollarization. They say a country should have its own national currency, the price of which should be determined according to market forces. In many cases, the national currency fulfills the role of a “buffer” to protect the economy from external shocks, giving the country more freedom. For example, if the monetary policy rate in the US is increased to deal with high inflation, dollars from different countries will flow into the US (given the high interest benefits). In Argentina, a floating exchange rate would reduce the value of the peso, and potentially increase inflation, although it would not directly affect the economy, as the peso would still be the main medium of circulation there. However, with dollarization, there would be a direct outflow of dollars from the country (if Argentina did not increase the rate of monetary policy as well), which would have more severe consequences for the economy. Thus, the national currency can be considered as a good way to prevent the internal monetary decisions of another country from directly affecting it. That is why the growth of dollarized economies is quite slow, and features vulnerability to external shocks. Dollarization also reduces a country’s ability to use the monetary policy rate to regulate economic growth and inflation.
In this regard, an important factor to consider is that if Argentina dollarizes, the Central Bank will be deprived of the opportunity to financially support both the state and the commercial banking sector. This is exactly what happened in European countries during the Eurocrisis in 2011. Additionally, dollarization requires access to a sufficient amount of foreign currency notes, which in the case of Argentina may be a problem for full dollarization of the country’s economy. On the other hand, large amounts of dollars would also be needed to restore the value of the peso through foreign exchange interventions.
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Dollarization and the abolition of the National Bank are associated with challenges. First of all, this is a political issue, because President Milei does not have a majority in the Congress, and the implementation of the mentioned decisions first needs the support of Congress. What’s more, technically, the Central Bank will need sufficient US dollar reserves not only to purchase currency in circulation, but also to create guarantees for commercial banks to deal with the potential risks of withdrawals.
Clearly, dollarization has both pros and cons. An important advantage is that it all but eliminates the risk of national currency devaluation and it stabilizes debt servicing. At the same time, it reduces inflationary pressure and makes the general macroeconomic environment more stable and predictable. However, it can also lead to fewer opportunities for the dollarizing country to conduct an independent monetary policy, as well as to high dependence on the economic and financial environment outside the country. In addition, the lack of ability to print new money should be considered, which limits the country’s ability to respond to liquidity needs during economic crises.
Dollarization and the abolition of the National Bank do not in themselves mean that government leaders will have better fiscal discipline. Rather, it simply excludes the printing of notes to avoid default. That is why most economists believe that if a state has the right fiscal and monetary discipline to avoid default, it is better off sticking to its own national currency with a floating exchange rate, and conducting an independent, targeted monetary policy.
The dollarization of the Argentine economy is likely to have a positive effect on reducing the rate of inflation, however, as experience and empirical analysis show, a slowdown in the rate of economic growth is expected, which may in turn lead to more severe economic problems. Further, it will be difficult for Argentina to return to their own national currency in the future, should they decide to do so. Nevertheless, it appears that the Argentine people, weary of the challenging economic conditions, are willing to explore a completely new approach. The extent to which President Milei’s administration will meet their expectations remains to be seen.
