Javier Milei was elected president of Argentina on the strength of a radical promise: that he would replace the highly inflationary Argentine peso with the stable US dollar. Yet the latest reports suggest that such dollarization is now a “medium-term” goal, rather than an immediate priority, and dollarization is not on the official agenda of Milei’s meetings this week with the International Monetary Fund and members of Joe Biden’s administration.
US dollars are already ubiquitous in Argentina, as any visitor can attest. So why should dollarization be so difficult? Because — as even those of us who favor the policy have to admit — no matter how it happens, if it does, it will be messy.
The simplest way for Argentina to dollarize would be to inflate the peso even more. For purposes of argument, imagine a peso inflation rate of one billion percent a year. Pesos would be worthless, and transactions would be consummated with US dollars (or in some cases in crypto, which also is popular in Argentina). The problem is that current peso holders would be left with nothing. That would be unfair, and it also might torpedo support for other parts of Milei’s agenda.
To put it in more general terms: The question is not how to adopt a new currency, it is how to adopt a new currency and retain a reasonable value for the old one. Argentina, according to some estimates, would need about $30 billion to back the retired pesos.
So could the government dollarize by seizing the dollar holdings of wealthy Argentines, and using those assets to back pesos? Peso holders would convert into the more stable dollars, enthroning the dollar and deposing the peso.
But again, the politics would be difficult. Furthermore, a lot of those dollars are in the US, under mattresses, or in otherwise difficult-to-reach places. The plan also seems unfair and would turn the elites against Milei.1
A more practical plan, then, would be to borrow lots of money, stabilize Argentina’s fiscal position through a mix of tax hikes and spending cuts, and promise to convert pesos into dollar at some fixed rate. That is essentially how Ecuador dollarized in 2000, and it has stuck.
Now we’re getting somewhere. Still, some major problems lie ahead. The first is that the IMF does not generally favor dollarization, and is unlikely to lend to Argentina for that purpose. (Ecuador, if you’re wondering, did not consult with the authorities and announced its dollarization plan as a surprise — after consummating some borrowing from the IMF.)
Another question is how to choose a rate of conversion for pesos to dollars. The government might look to current black market rates as a rough guide — but the correct rate, post-policy shift, would not be the same as the market rate right now. If the government were to peg the peso too high, in the short run prices in Argentina would have to adjust downward, if only because the demand for pesos would be rising (let’s generously assume the peg is credible). That would lead to deflationary pressures, which would likely harm the economy.
Alternatively, if the government pegged the peso too low to the dollar, there would be even more inflation in the short run, as people would be all the more inclined to unload their pesos.
The government is more likely to overshoot, pegging the peso too low in order to avoid a deflationary recession and because it would require raising fewer dollars. In this case, the peso would lose even more value right now, and the rate of inflation would accelerate. In fact, this is the most likely scenario for the early months of the Milei administration.
It would be a version of the first plan mentioned above — namely, dollarization through the outright destruction of the peso, whether intentional or not. Either the value of the peso would collapse, or the higher inflation rate would induce Milei to advance dollarization as quickly as possible, even if it is done at quite unfair rates.
In any case, one lesson is that dollarization tends to go more smoothly if people don’t know it is coming. That is not an easy option for the forthcoming Milei administration. There are alternate paths, but they are not necessarily the ones Argentines might want. So another lesson is to expect messy surprises, no matter what anyone is telling you in the short run.
1One logical plan — which has no real chance of happening — would be for the US Federal Reserve to give Argentina some dollars, or lend them dollars on favorable terms. The demand for dollars would increase, so that would not have to be inflationary for the US. Over time, the Fed would earn more on seigniorage, so it might even be a profitable deal. Still, such an act lies well outside the charter and fiduciary responsibilities of America’s central bank.
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