Inflation is Argentina’s biggest problem. It is causing instability and widespread poverty. Argentina is in recession at a time when the rest of the world is growing, including most of its main trading partners. By my measurement, inflation has reached 239 percent annually (as of November 9, 2023). Attempts to prevent the exchange rate from fully reflecting the magnitude of inflation have distorted shortages of goods and lost production. The Argentine peso is so unreliable that Argentinians already transact in US dollars when they can.
And yet, the idea of fully dollarizing Argentina and eliminating the peso has received vigorous criticism from numerous economists, politicians, experts and other observers in Argentina and elsewhere. They are so ideologically committed to central banking that they cannot see that the BCRA is a disaster, with no prospects for short-term reform. Because many misconceptions persist about dollarization, I have compiled the most common objections and their rebuttals for convenient reference in this brief document.
Objection 1. Argentina lacks enough dollars to dollarize.
Answer: Even valuing the pesos at the unrealistic official rate, Argentines own more than twice as much in foreign currency as they do in pesos. Argentina has more than enough dollars to dollarize. People keep most of their dollars out of the banking system because they legitimately fear that the government could confiscate dollars in the banking system.
Objection 2. Dollarization would have to occur at a much higher (more depreciated) exchange rate than even the current parallel market rate.
Answer: This objection is perhaps the most common misunderstanding about dollarization. It rests on the assumption that the Central Bank is the most important factor in the market for buying and selling pesos against dollars. The central bank’s entire balance sheet is less than the estimated amount of Argentine foreign currency holdings, not to mention the dollars that foreign investors could bring to Argentina. If dollarization were to occur at a market-determined rate today, the likely exchange rate would be somewhere between the artificially low official wholesale rate of 350 pesos per dollar and the unnecessarily high parallel market rate of around 1000 pesos per dollar. dollar, which remains high due to the illegality of the transactions.
Objection 3. And what about LELIQs, a time bomb on the central bank’s balance sheet?
Answer: Dollarization offers the best opportunity to defuse the time bomb. Without it, the LELIQs problem will continue to worsen. The underlying concept of restructuring finances to take advantage of a more stable and favorable investment climate is familiar in both private and government finance. After dollarization, interest rates, including those on LELIQs, will fall substantially.
Objection 5. Dollarization will not solve the problems of the banking system, which is small for the size of the economy and does not promote economic growth to a large extent.
Answer: In fact, the example of Ecuador suggests that dollarization will go far in turning the banking system into an agent of growth. When Ecuador dollarized in January 2000, the banking system had been in crisis for almost a year. The deposits were frozen. The confidence generated by dollarization encouraged Ecuadorians to deposit funds in banks. The illiquid banking system regained liquidity. Dollarization allowed banks to make loans for much longer periods and at much lower nominal interest rates than they had previously been able to do.
Objection 6. Dollarization implies preconditions that Argentina lacks, especially in government finances.
Answer: The experience of other dollarized countries has shown that dollarization does not require preconditions. Apparently, no country that has wanted to dollarize has been unable to do so because it lacked sufficient foreign currency, a balanced budget, or other characteristics. Critics are misled by a false analogy with central banking. Under central banking, it is extremely important that the government budget be balanced or close to it. Otherwise, the government will demand that the central bank create money to finance deficits, and the central bank will not be able to refuse. Under dollarization, there is no domestic central bank to finance deficits. Consequently, dollarization forces the government to make its finances more sustainable.
Objection 7. Dollarization will not solve the Argentine government’s budget. The important thing is the budget, not the currency.
Answer: Dollarization imposes what economists call a hard budget constraint. The government can only spend as much as it collects in revenue plus what participants in financial markets are willing to lend to it. Central banking involves what economists call a flexible budget constraint. The government can spend more of its revenue plus its loans in the financial markets because the central bank can finance it, possibly creating inflation to do so. By eliminating the central bank, dollarization creates much more incentive to fix the budget than would be the case under central banking.
The space of this note does not allow me to include my response to many other objections to the possibility of dollarization. Those interested can consult the full text at https://www.dropbox.com/scl/fi/ksh8ly3psc4205ik0mrbf/Working-Paper-244-2.pdf?rlkey=qg5owcpgx5229no2tesarqu34&dl=0
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by Steve Hanke
