The good news is that President Javier Milei seems to be backing away from plans to dollarize the Argentine economy. That is also the bad news.
Don’t get me wrong: Dollarization would be great — if the country had a spare $30 billion to back each peso with dollars. But Argentina doesn’t have that extra money ready at hand, and so the Milei regime is looking for some form of dollarization that can both work and be worthy of the name.
In a recent speech, Milei seemed to suggest that formal dollarization — as seen in El Salvador, Panama and Ecuador — isn’t going to happen. His remarks are somewhat confused, so it might be helpful to review different types of dollarization and what they mean.
First is what I call the Zimbabwe path to dollarization: Just push the rate of inflation into the billions or trillions, and the native currency will be replaced by the US dollar. The mechanics are easy, but the process is tragic. It impoverishes the poor and members of the middle class who have been saving in the national currency, or who have written contracts or debts in it.
A second method is to take the domestic currency and try to peg it to the dollar on a one-to-one basis. Argentina tried that in 1991. If Milei managed to establish a one-to-one peg of the Argentine peso against the dollar today, ask yourself: Which asset would you rather hold? The dollar of course, because of its greater security. Not surprisingly, the earlier Argentina dollar peg collapsed in 2002 once uncertainty about its credibility took hold, and high inflation followed once again.
Milei hints at this method when he mentions making the peso fixed “like a rock” (“como una roca”). But this path is dominated by strict dollarization. If the Argentine government had enough dollars to promote a one-to-one peg, it would do better by converting all pesos to dollars outright, and giving up on the peso.
A third path is currency competition, a concept Milei mentions early in his remarks. In this scenario, which seems to be Milei’s primary new plan, the dollar and the peso would circulate side by side and compete with each other. As the economy grew, the use of the dollar would increase, while the peso would fade away.
This plan satisfies Milei’s desire for a broadly libertarian solution, but it doesn’t stabilize the value of the peso. It is already the case that both currencies, plus a lot of crypto, circulate in Argentina. And dollars have been subject to a lot of regulations and non-market, fixed exchange rates in the past. It might be good to remove many of those restrictions, as Milei has, but such deregulation will not itself lower the rate of inflation. In fact, if the peso is going to fade away, it will lose all the more value upfront, as markets come to expect its eventual euthanasia.
In reality, this scenario resembles the Zimbabwe path too closely for comfort. Until Argentina’s fiscal problems are solved, peso inflation must continue, if only to service the national debt. In fact, to the extent currency holders can shift into dollar holdings more easily, inflation may even accelerate. The base of peso holdings to be taxed by inflationary seigniorage would grow ever narrower, necessitating an ever-higher inflation tax to keep the government in business.
As long as the dollar is full-fledged competition, stabilizing the peso is not easy. The fiscal problems of the country still need to be addressed.
A final alternative, which does not involve dollarization, is for the government to solve its fiscal issues and then tighten monetary policy until inflation rates fall to reasonable levels. In other words, work on getting the peso back into shape. That involves the risk of inflation resuming. But both Brazil and Mexico, to choose two examples, have moved from crisis-prone, high-inflation economies to relative macroeconomic stability. There is some hope that Argentina can do the same.
If that path seems too improbable, then hard dollarization it must be, with its $30 billion price tag. The intermediate methods can in some ways be called “dollarization,” but they are not stable and they tend to collapse into further hyperinflation.
There is no way around it: If a government has fiscal difficulties, a stable currency — whether it be the peso or the dollar — costs a lot of money. As tempted as he might be, Milei cannot afford to ignore this fact.
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