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Saturday, December 9, 2023

“The country ties its hands behind its back” (Sylvain Bersinger, Asterès)

LA TRIBUNE – Why does Javier Milei want to convert Argentina to the American dollar?

SYLVAIN BERSINGER – Argentina’s biggest problem is inflation and according to Javier Milei, dollarization would help break inflation. On this point, I think he is right. Unlike us, who suffer from inflation mainly because of rising energy prices, the cause of Argentina’s three-digit hyperinflation comes above all from the country’s monetary policy. The country’s central bank is printing too much money, which is decreasing the value of the Argentine peso.

This phenomenon is further accentuated by imports which are often made in dollars or euros because almost no foreign company wants to be paid in pesos and asks Argentina to convert its currency into stronger currencies to purchase products. The problem is that imported goods see their costs increase when the currency depreciates because you have to spend more pesos to obtain the same quantity of dollars or euros.

The future president therefore wishes to put an end to money printing by closing the central bank that issues the peso and abandoning the latter in favor of the American dollar which is much more stable.

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Why is the Argentine Central Bank printing too much?

This is a problem that is not new. We must understand that hyperinflation very often comes from a desire to finance too large a budget deficit. And precisely, the country’s monetary policy is strongly influenced by the power in place which has often decided to print money to finance its budget indirectly.

Javier Milei said he wanted to dollarize Argentina by setting up a “system of free competition of currencies” from which the dollar would emerge, ultimatelywinner against the peso. What does that mean ?

It’s quite confusing, but the basic idea is that to dollarize, you would need dollars in the country. The problem is that today the Argentine Central Bank has very few dollars. But Javier Milei affirms that, certainly the monetary institution does not have any, but the Argentines have a lot of dollars hidden under their mattresses because they do not want to keep pesos. Moreover, many purchases in dollars are already made inside the country, but illegally and using a parallel exchange market.

Milei’s idea is therefore to say that if we formalize dollar payments in the country, households would pour their dollar reserves into the economy. And we’re talking about a hefty amount of $200 billion, which is just an estimate, however. Because it is only a bet on an economic theory which does not bring together all economists.

If Javier Milei succeeds in his country’s transition to the dollar, what would be the positive consequences for the Argentine economy?

Apart from stopping inflation, which is already a very good thing, there wouldn’t be much. But we can imagine that this policy could boost growth since the population would be less worried about the devaluation of their money and therefore would be more inclined to consume. In addition, there would be fewer delays and problems with wage indexation, so Argentine households would have a better financial situation.

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Other countries like Panama in 1904, Ecuador in 1999 and El Salvador in 2000 have already abandoned their currencies to switch to the US dollar. Why did they do this and how did it happen?

These three countries switched to the dollar in very different contexts. Panama is a former American protectorate so dollarization happened naturally very early because it has always been very dependent on the United States. For Ecuador, dollarization took place in a chaotic and emergency context, even though the country was in the middle of a putsch.

On the other hand, for El Salvador, this decision was considered and implemented in cooperation with the IMF to curb inflation. But again, the situation is different from Argentina. El Salvador is geographically close to the United States and trades a lot with this country, so it is very dependent on the dollar-peso exchange rate, which made dollarization very interesting since the drop in the value of the Salvadoran peso increased the costs of imported products. Additionally, El Salvador has a strong American diaspora who send money to their family back in the country, so having the same currency as the diaspora is very convenient.

For Argentina, dollarization seems less relevant because the diaspora is smaller than that of El Salvador. The country trades less with the United States than the latter. The economist Paul Krugman even said that it would be better for Argentina to convert to the euro because they sell more to Europe than to the United States.

Are there any adverse effects of dollarization?

Yes, and the biggest risk is that of not being able to fight a recession. If the Argentine economy fell into recession, the government would not be able to support its economy by implementing a monetary recovery policy which is normally done by lowering key rates to revive borrowing and investment and consumption.

And for good reason, Argentina will no longer have a central bank and will be dependent on the monetary policy of the American Federal Reserve. In other words, the country is tying its hands behind its back.

But other problems could also appear. If the American Federal Reserve decides to increase its key rates more than the European Central Bank for example, this could cause the dollar to appreciate against the euro and make Argentine companies lose competitiveness since the products they export would automatically cost European consumers more.

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This could harm the country’s trade balance. Worse still, in the event of a trade deficit, Argentina would see more dollars leaving the country than coming in and this would create a lack of currency which would increase the interest rates on loans which, ultimatelycould reduce borrowing, investment and consumption and push the country towards recession even though it would have no means of implementing a monetary recovery policy…

Finally, the last risk is that of an outburst in the event of bank failures. In 2008, central banks lent a lot of money to their national commercial banks to prevent them from collapsing. But if Argentina abolishes its central bank, it will no longer be able to help its commercial banks except by asking for help from the United States which will not have much interest in spending billions or even tens of billions to save the Argentine banks. But if the government can’t stop a banking crisis, people can’t get their money back and the entire economy could collapse.