Dollarisation is not a panacea for Argentina

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The writer is a professor at the Universidad Torcuato Di Tella and visiting professor at the school of public policy at the LSE

The prospects of official dollarisation in Argentina seem to have increased after Libertarian hopeful Javier Milei ranked first in the country’s primary elections.

As undertaken in Ecuador and El Salvador, dollarisation entails the adoption of the dollar as the sole legal tender. It remains popular in Ecuador thanks to its part in contributing to two decades of low inflation. This is surely inspiring hopes in Argentina that the move could end years of chaos. But it is no panacea for the country and there are very large obstacles to adoption.

Dollarisation usually requires a stock of liquid dollars to replace the monetary base and to build a liquidity buffer in the US currency — say, 20 per cent of bank deposits — to counter any runs on the banking system. This substitutes for the role of a central bank as lender of last result, which, under dollarisation, is virtually eliminated.

In Argentina, this amounts to roughly $20bn to $25bn in international reserves at the market-based, or parallel, exchange rate. Is that feasible for the country? Given its central bank has recently posted negative net reserves, official dollarisation would require a very substantive loan. This would no doubt be a tough ask for the country given its poor standing in international markets — illustrated by the spread on its sovereign debt yields over US Treasuries of more than 20 percentage points.

Even if it could raise the funds, would dollarisation be worth it for Argentina? Among the downsides, it is virtually irreversible. To forcefully convert foreign currency contracts to a currency still in circulation is arduous and questionable, but still feasible. This was the case after the 2001 demise of Argentina’s currency board system which had pegged the peso to the dollar. But to switch from a hard currency such as the dollar in wide circulation to a weaker one is virtually impossible.

In addition, the two countries that officially dollarised in the heyday of super currency pegs in the late 1990s — El Salvador (in normal times) and Ecuador (in a crisis) — have since learned that they are exposed to external shocks (such as oil prices, Chinese competition, global financial cycles, pandemics and wars) but without the option to cushion the impact by softening the exchange rate.

There are some upsides. Unilateral dollarisation promises Argentina broadly the same benefits as its soft version, the currency board, did in the early 1990s. It could solve the problem of inertia in tackling inflation through monetary policy. And it would also help rein in the country’s chronic fiscal imbalances by cutting the monetary financing of the deficit.

But Argentina could learn a great deal from its own recent history. The currency board was implemented smoothly because the government had previously restructured its debt, easing fiscal deficit pressures at a time when the dollar weakened globally. Moreover, the country moved forward with reforms that may have achieved stability even under more traditional exchange rate arrangements, as most of its inflation-stricken neighbours did in those years.

However, the government later relapsed into fiscal indiscipline, funded by an enthusiastic emerging market investor base. This was right before global dollar strength triggered a sequence of currency crises that shook the faith in Argentina’s dollar straitjacket. Then in 2001, the country’s treasury, without access to finance and without a central bank to fund its deficit, ending up printing fiat money, thereby embracing the monetary discretion that the currency board was supposed to remove. The currency board was scrapped in 2002.

The fact that dollarisation, either soft or hard, cannot by itself solve the fiscal problem is again illustrated by Ecuador. After adopting dollarisation, Ecuador continued to increase public spending (doubling to $44bn during the Correa administration of 2007-17 alone) and defaulted twice on debts despite an unexpected oil boom. And the country’s economy has stagnated in real per capital terms for the past 10 years.

Impracticable and opaque, dollarisation may not be much more than a convenient sleight of hand — an appealing mantra to shrug off the complications of a true stabilisation effort by attaching magic recovery powers to the dollarisation fairy. Let’s hope that Argentina’s despair at its own history does not breed a new, more permanent fiasco.

Marina Dal Poggetto, managing partner at EcoGo, contributed to this article.