Why dollarization (for Argentina)
A functioning economy relies heavily on the health of its currency. Without a stable currency (Argentina currently has a monthly inflation rate above 10%), we cannot maintain an economy that evolves over time rather than perpetually lurching from one crisis to another. When the monetary problem remains unsolved, no economic plan or even a super minister can bring order to the country’s economy.
The primary challenge any monetary stabilization program faces is establishing credibility. It matters little whether a monetary stability program is technically sound; without credibility, it is doomed to failure. For instance, declaring the independence of the BCRA (Central Bank of Argentina) is ineffective if that declaration carries no credibility. Given the level of institutional uncertainty in our country, rapidly building high levels of credibility appears nearly impossible.
Unlike other monetary stabilization plans, the credibility of a well-designed and well-implemented dollarization strategy depends less on the political will to uphold such a monetary regime than other monetary regimes. It is more straightforward for a government to abandon a fixed exchange rate with the Argentine peso or limit the competition of the dollar with the peso than to take away people’s dollars. Another advantage of dollarization is that it doesn’t involve introducing a new currency into the market. The market has already chosen the dollar, and embracing dollarization is essentially an acknowledgment of this fact. Attempting to maintain the peso, adopt a different currency like the Brazilian real, or create a new regional currency poses the difficult challenge of convincing people to abandon the dollar in favor of a currency they do not trust. These models may appear promising in theory but often prove unworkable in practice.
In the ongoing debate about whether dollarization is right for Argentina, two essential issues come to the forefront. Firstly, we must recognize that we are currently in what economists term a “second-best” scenario, where the available alternatives are suboptimal. Dismissing any monetary reform, such as dollarization, merely because it falls short of perfection is counterproductive. In such a scenario, no monetary reform would ever gain approval. Secondly, we must take a realistic view of the feasible alternatives for our country. Frequently, we hear arguments suggesting that Argentina should follow the examples of countries like Peru, Uruguay, or Brazil, which maintain their own currencies. This implies that Argentina must “get its act together instead of opting for dollarization.” However, this viewpoint oversimplifies a complex situation. Argentina has repeatedly demonstrated its struggles in “doing things right.” Monetary policy is a powerful tool, and when mismanaged, it can be highly dangerous. In such cases, adopting another country’s currency may be the safer choice. Unfortunately, due to populist policies, Argentina today is closer to resembling Ecuador than Peru, Brazil, or Uruguay.
However, it is crucial to consider international experiences to understand how neighboring countries have tackled their inflationary problems and dispel fears regarding dollarization. In particular, the fear that dollarization would expose the country to external shocks. When we analyze the performance of dollarized economies in the region, we find that these fears are largely unfounded. Major shocks, such as the 2008 financial crisis, commodity price fluctuations, and the COVID-19 pandemic, have significantly impacted Argentina more than Ecuador.
This fear is exaggerated for several reasons. Firstly, the Central Bank can often be the source of the most destabilizing shocks. In Argentina, the BCRA generates more intense and long-lasting imbalances than those originating from the rest of the world. Indeed, monetary policy frequently magnifies the impact of external shocks. Secondly, it is a conceptual mistake to view dollarization as merely a fixed exchange rate regime and assume that this is the only policy change. In reality, it represents an institutional regime shift that profoundly alters the functioning of the economy.
In conclusion, I leave you with two final questions regarding the benefits of a well-designed and well-implemented dollarization strategy. Firstly, is it a viable solution for Argentina? While not the only option, it might be the one with the greatest likelihood of success. This is because alternative plans hinge on the credibility that the Argentinean political system often fails to generate. A new failure would push the country further down the path of no return, leaving no room for error.
On the other hand, a well-executed dollarization strategy maximizes the potential for an expansionary adjustment. Without a positive expectation shift, the inevitable fiscal adjustments will prove contractionary, eroding the political capital needed to implement other crucial reforms the country desperately requires.
The original post in Spanish can be found here.
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