Once again Argentina has an economic crisis on its hands. Last year inflation reached 54% and the peso lost almost 40% of its value. That led the government to reimpose capital controls, and now each Argentine is allowed to buy only 200 U.S. dollars a month at privately owned banks. The black market, of course, has no limit, but Argentines will pay 110% more than the legal rate for those dollars.
The pandemic has made things worse. In May, Argentina defaulted on its sovereign debt. In September, with foreign reserves dwindling, the government tightened its capital controls, levying a 35% tax on top of the 30% tax already charged on dollar purchases. As government spending soared to cope with the crisis, and revenue plummeted, the Central Bank of Argentina cranked up its printing presses. But even working at 100% capacity, the presses can’t print enough money, so Argentina is using its foreign reserves to ship in banknotes from abroad.
What can Argentina do to stabilize its monetary system and fix some of its economic failures? It should “dollarize,” or adopt the U.S. dollar as its official currency and allow the peso to fall out of circulation. U.S. economists such as Steve Hanke at Johns Hopkins University and John Cochrane at the Hoover Institution have long been advocates. The tightening of capital controls reignited the debate among local economists. And Argentines are increasing their dollar purchases, a sign that they expect at least a devaluation soon, if not dollarization. But both Argentina’s president and economy minister seem to dismiss the idea and instead want to encourage people to save in pesos and forget about the dollar.
It sounds radical: use another country’s currency as your own? But several countries have done this or something similar. In Latin America, Panama has used the dollar as its official currency since 1904. Ecuador dollarized in 2000, and El Salvador followed in 2001. Before dollarization, Ecuador’s economy was in crisis, but switching to the dollar steadied its banking and monetary system and its economy began growing again. George Mason University economics professor Lawrence White notes that dollarization also constrained the anti-market government of President Rafael Correa, who took office in 2007 seeking to pursue a “socialist revolution.”
Correa aligned himself with Venezuela President Hugo Chávez, and it’s easy to imagine that without dollarization, Ecuador might have ended up like Venezuela. Now Venezuela, battered by hyperinflation, may be moving toward dollarizing after long resisting it. The greenback is already widely used there—a survey in October estimated that 54% of transactions were conducted in dollars.
Other countries also have had success with turning over their monetary policy to the U.S. Zimbabwe quelled annual inflation that topped 1 million% after it legalized the use of the dollar and other hard currencies in 2009. The dollar is also the official currency in several Pacific and Caribbean islands. Hong Kong has famously pegged the Hong Kong dollar to the U.S. dollar since 1983.
Argentina established the Central Bank of Argentina in 1935, and since then, the country has suffered eight currency crises. In 1991, faced with hyperinflation, it decided to take a bold step: It launched a currency board that pegged the peso to the U.S. dollar. The idea worked and the economy grew quickly for the next several years. But the country never took the full leap to dollarization, and its commitment to monetary stability waned, thanks to soaring government spending and a strong dollar. The board devalued the peso in 2001 to make Argentine exports more competitive and so the country could more easily pay back its growing debt in pesos (it later defaulted on its dollar-denominated debt). Monetary disarray has reigned ever since.
In the short run, dollarization will boost Argentina’s stricken economy by bolstering confidence in its future. In the long run, dollarization will tame the country’s destructive inflation, holding price increases to close to U.S. levels. Argentines will no longer be taxed, in effect, for holding money, as they are now if they have any pesos in their pocket. And because inflation makes it hard to figure out what consumers value (it distorts price signals, as economists say), prices will more accurately reflect the demand for goods and services. This allows greater long-term planning and investment, crucial for sustained economic growth.
Turning Off the Presses
Dollarization would also limit government spending because the days of printing money to fund the budget would be over. The Argentine public sector represents almost 40% of gross domestic product, so putting the brakes on government spending will create more space for the private sector to flourish.
In any event, Argentina is already partly dollarized by default. People buy and sell goods and services in pesos, but they save in U.S. dollars. And because exchange rates in both the legal and illegal markets are highly volatile, people spend much of their time following currency movements during the workday, hurting productivity and the economy.
Critics don’t like how dollarization ties a government’s hands. It might hamper a government’s ability to finance potentially useful projects. With monetary policy largely controlled by the U.S. Federal Reserve, Argentina couldn’t pursue its own policy that it could tailor to local conditions.
Indeed, when the peso was pegged to the dollar in the 1990s, the dollar’s appreciation caused the peso to become much stronger, hurting exports by making them more expensive. That could also occur under full-scale dollarization, but it’s important to remember that the bigger problem in the 1990s was President Carlos Menem’s borrowing binge, forcing interest rates to rise and jacking up business costs. Moreover, while a strong dollar may reduce exports in the short run, a thriving private sector forced to become more efficient and benefiting from cheaper imports would eventually regain its export competitiveness.
Advocates argue that restricting government discretion is exactly the point of dollarization, given Argentina’s history of profligate spending, high inflation and debt defaults. This track record indicates there is no reason to believe the country would pursue a responsible monetary policy and get a grip on spending any time soon.
What’s Not to Like?
Low inflation. A reasonable government budget. Faster economic growth. But how does Argentina get there? To dollarize, the first step would be to eliminate capital controls. The government then needs to adopt legislation allowing it to tax and spend in U.S. dollars. The demand for dollars would determine the exchange rate for pesos being taken out of circulation. That will resemble the rate in the illegal market, resulting in a massive depreciation of the peso because of the enormous spread between the rates in the legal and illegal markets. Even if dollarization produces immediate benefits such as renewed confidence in the economy, the depreciation will cause pain in the short term and test the government’s commitment to dollarization.
The flood of pesos printed during the pandemic and the Central Bank’s paltry foreign currency reserves complicate this plan. If people rush to dump their pesos and dollars are scarce, the exchange rate will soar, causing even more pain. So dollarization would work best if it’s accompanied by a government strategy to boost the supply of dollars in the economy. It could do this by selling state-owned companies, such as the national airline and its national oil company—which both lose money—for dollars. It could even put a “For Sale” sign on the Central Bank building.
Importantly, Argentina must avoid the temptation of “workarounds” to dollarization. During the currency board era, both the national and local governments issued bonds that served as quasi-currencies to finance more spending. Repeating that mistake would wreck the credibility of dollarization.
Full dollarization won’t solve all of Argentina’s problems. Political instability and corruption are still rampant. The country suffers from confiscatory taxes and stifling regulations. Nevertheless, dollarization would be a major first step to address these issues because a dramatically constrained government would have no choice but to undergo more market-oriented reforms. The people of Argentina have already voted with their wallets to use dollars as much as they can. Dollarization would acknowledge reality and pave the way toward the country’s economic revival.