Cry for Milei's Argentina

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This is a daunting task, given Argentina’s dismal economic track record over the past few decades and history as a serial defaulter – the latest episode being the 2020 restructuring of $65 billion in sovereign debt.

With its GDP expected to shrink by 2.5% in 2023 and inflation running above 140%, Argentina’s economic outlook appears bleak. The peso has fallen to record lows against the US dollar, causing the gap between the official exchange rate and the black-market rate to exceed 150%, and the country is at risk of defaulting on its debt for the tenth time. As has been the case historically, addressing Argentina’s macroeconomic imbalances will require reducing public spending without exacerbating the economic crisis.

To that end, Milei has proposed dollarizing the Argentinian economy and establishing the greenback as the country’s sole legal tender. This approach is not entirely unprecedented. Previous attempts to introduce macroeconomic discipline included the currency board system, which pegged the peso one-to-one to the dollar for almost a decade, before collapsing in the early 2000s amid yet another debt crisis. Milei’s plan would scrap the peso altogether, based on the belief that shutting down the central bank’s «printing press» will effectively rein in public spending.

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But this is wishful thinking. Public spending is driven by many factors beyond just «easy money», and dollarization would likely make it even harder for Argentina to finance its deficit. Moreover, there won’t be any scope for adjustment through the exchange rate – for instance, to boost competitiveness – because control over monetary policy will be ceded to the US Federal Reserve. As Argentina’s experience with the currency board showed, exposing the domestic economy to external discipline comes at the cost of flexibility, which notably hampered Argentinian policymakers’ ability to respond to external shocks in 2001.

Contrary to what Milei apparently believes, dollarization poses a challenge to achieving macroeconomic stability. Wise policymakers should resist it rather than encourage it.

The experiences of former Soviet republics like Armenia and Georgia are a case in point. After gaining independence in 1991, both countries established their own currencies. But dollarization became widespread, owing to policies aimed at managing the transition to a market economy, controlling hyperinflation, and addressing sharp currency depreciations. Amid heightened macroeconomic uncertainty, households resorted to holding dollars as a safe store of value. Remittance inflows also contributed to the growth of dollar-denominated bank deposits (to some extent, they still do).

The problem is that dollarized banking systems are vulnerable to destabilizing exchange-rate fluctuations, sudden shifts in capital flows, and external shocks in general. Capital inflows, for example, can exacerbate currency mismatches, leaving recipient countries’ currencies susceptible to exchange-rate depreciation. Mitigating this risk often requires the imposition of additional constraints on monetary policy.

But macroeconomic stability is not the only issue at stake. National currencies represent monetary independence and play a significant role in shaping cultural identity. Armenia’s central bank channeled this sentiment at an international conference it hosted in September titled «We are the dram», marking the 30th anniversary of its national currency. As the organizers put it, «The dram is more than a currency. It speaks to who we are, and to everything we have overcome as a nation».

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Monetary sovereignty is an essential feature of modern states and economies. It involves not just the state’s authority to issue currency within its own territory but also the power to manage the money supply and set interest rates, oversee and establish exchange-rate regimes, and impose currency and capital controls that affect central-bank reserves. The currency that the state issues is recognized as legal tender, which means it must be accepted for the purchase of goods and services, and for debt repayment. Central banks ensure that the domestic currency flows through the banking system, and they serve as lender of last resort to commercial banks.

Against this backdrop, Milei’s plan to dollarize Argentina seems to confuse monetary sovereignty with control over the mechanisms for invoicing, settling transactions, and accumulating savings. Moreover, it aligns with the libertarian belief that the state’s role and size must be dramatically and irreversibly reduced.

This approach is questionable, to say the least. Monetary sovereignty is a vital public good that requires the support of credible institutions to bolster economic stability and democratic governance. Dollarization and the voluntary surrender of monetary independence are signs of economic and political fragility. This does not bode well for the future of Argentina’s economy or its democracy.

© Project Syndicate 1995-2023