Understanding the Disagreement in the Dollarization Debate

It is important to be conscious about assumptions used in different arguments.

This post is a follow-up from my latest about the dollarization debate in Argentina. In my previous post, I focused on how dollarized countries can access LOLR services. The topic of this post is why experts differ on whether dollarization is a promising idea for a country such as Argentina.

Reason 1: The Nirvana Fallacy

If it weren’t because it is quite present in the dollarization debate, discussing the Nirvana fallacy would not be necessary. Comparing the limits of real-world dollarization with the benefits of an ideal but impossible central bank would be a Nirvana fallacy. It is a no-brainer that a theoretical perfect central bank is better than any real-world dollarization. It is also a no-brainer that the theoretical perfect central bank has no counterpart in the real world.

A sensible assessment of dollarization needs to be realistic about the feasible alternatives a country faces. For instance, Argentina does not face the option of deciding between dollarization or a high-quality central bank. Argentina’s decision set includes dollarization and a very erratic and inefficient central bank. A fine-tuning monetary policy requires a scalpel; Argentina has a chainsaw.

Reason 2: The Credibility Assumption

The anti-dollarization position I have in mind states something like this: “If we work on good and credible reforms, then we won’t need to dollarize Argentina. Other countries have done so, therefore we can do it as well.”

I agree that dollarization is likely not needed if credible and durable reforms occur. However, this line of argument rests on the assumption that Argentina can build credibility. Given Argentina’s history, I think it is reasonable to question this assumption.

Argentina’s credibility is a two-level problem.

• Level 1: Argentina’s politics is non-credible

• Level 2: Argentina’s politics is unable to produce credibility

Those in favor and against dollarization agree on Level 1. The disagreement is on Level 2. Those against dollarization assume (maybe implicitly) that Argentina’s politics can build credibility. Those in favor of dollarization do not believe this to be the case. They see dollarization as a means to import credibility and durable reforms. Recall that in Ecuador dollarization survived the popular and powerful Rafael Correa. Dollarization is an institutional reform first, and a monetary policy reform second.

Let’s avoid a wishful thinking problem by ignoring what we want Argentina to be by looking at the empirical evidence provided by history. Since 1945, Argentina has had a 60% yearly inflation rate. High and volatile inflation has been a problem for any political party in a democratic and non-democratic government. Any monetary policy design you can imagine has failed to put inflation under control, except during convertibility. Even the widespread inflation targeting managed by an Ivy League team of economists ended in one of the many currency crises experienced by Argentina. National laws are reverted or ignored by the same congressmen that vote for them in the first place, while the judiciary is unable or unwilling to act to protect the citizens against state advances on their property. In short, there is no evidence that Argentina can create credibility. Arguing that Argentina can avoid dollarization by doing structural reforms assumes the problem away.

To be clear, what I´m saying is that there is no proof that Argentina´s politics can create credibility and, therefore, dollarization critics ultimately rest on an assumption. Given Argentina’s historical record, those who oppose dollarization should produce an explanation of why Argentina can build credibility to support their objections.

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Previous post on this topic:

Dollarization and Lenders of Last Resort

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