InsightsDollar deliberations

Dollar deliberations

Dollarisation back on the agenda in Argentina following Javier Milei's early success in the recent presidential primary election.

The dollarisation of Argentina has become a credible scenario after the unexpected rise of Javier Milei to secure 30% of the votes in Argentina’s recent presidential primary election. Milei, a far-right libertarian, has some radical policy proposals that some have labelled ‘crazy’ but there are clear arguments in support of dollarisation. 

Trusting the dollar

Dollarisation aims to permanently strip the government of the power to manipulate the currency, particularly the ability to print money to finance the government’s deficits or provoke artificial, short-term growth spurts.

This might not be a bad thing for Argentina which has been stuck in a permanent economic crisis since 2018, lifting inflation to 114%. If you think this is madness, you must look at the mechanism through which the central bank injects money into the economy, called the leliqs. The leliqs (letras de liquidez) are short-term bonds that the central bank sells to commercial banks. The idea is that by exchanging leliqs for pesos, the central bank is retiring excessive pesos held by the commercial banks. The problem is that the central bank prints pesos to pay the interest on these bonds, and the amounts are such that paying them has become one of the primary sources of excess money creation. Paying yields of 118%, the nominal debt of the central bank more than doubles each year (in fact, the leliqs renewed daily represent 50% of the monetary base, the total money printed by the central bank in circulation). Thus, the central bank has put itself into a vicious cycle: issuing leliqs to reduce bank liquidity which inadvertently leads to printing more money, necessitating the creation of additional leliqs, and so forth. It is a self-perpetuating, inflationary machine.

As shown in Figure 1, the combined dollar value of peso and dollar deposits within commercial banks is decreasing, despite the high interest rates paid by the central bank in pesos through the leliqs and the peso borrowers in the banking system. In these conditions, it is no wonder that dollars are scarce. The more pesos the central bank prints, the more pesos people have to buy and the more dollars on the black market, making dollars scarcer in the official markets. The more pesos you have, the more you lose in dollar terms, increasing the incentive to buy dollars with pesos. Notice that the fall in dollar-equivalent deposits is worse than shown in the graph as it does not include the 22% devaluation that took place the day after the primary election.

Figure 1: Total ARS and USD deposits in Argentina in USD equivalent. Source: International Financial Statistics, International Monetary Fund.

A central bank and a government that puts itself in this situation should not be permitted to manage a country’s currency. And this is not an isolated incident. We are talking of a government that has caused major currency crises (huge rates of inflation and currency depreciation) in 1876, 1890, 1914, 1950, 1952, 1958, 1967, 1975, 1985, 1989, 2001 and 2018-2023.

Yet, the dollarisation idea has provoked a tsunami of criticism. Some say that it is impossible to dollarise Argentina because the country lacks the dollars to do it, forgetting two facts: first, Argentina is already spontaneously dollarised, as most contracts are denominated in dollars, and second, Ecuador faced a similar challenge in 1999, and as of January this year, it has successfully maintained dollarisation for 23 years. The decision to dollarise Ecuador’s economy effectively curbed hyperinflation, halted the precipitous decline of the sucre and stabilised the financial market. These accomplishments played a significant role in resolving its economic crisis.

Amidst this criticism, it is often overlooked that dollarisation consists of denominating all contracts in dollars, including wages, loans, assets and, crucially, the banking system’s accounts. Cash is a small amount. It may disappear within a few years in modern countries.

Another aspect that tends to be overlooked is the fact that the economy’s behaviour will change under a new monetary regime. As soon as it is dollarised, people bring in their dollars, which they had deposited abroad because, in Argentina, they were in danger of being exchanged forcibly by the government for pesos. Figure 2 shows how deposits in pesos in Ecuador fell by 50% when measured in dollars from February 1998 to December 1999 and then bounced back exactly when the economy was dollarised, recovering the February 1998 level by June 2002. This can be financed very quickly. Compare this graph with that of Argentina. In Ecuador, people had lost 50% in dollar terms by December 1999. In Argentina, they have lost 60% since March 2021 without considering the last devaluation.

Figure 2: Total deposits in Ecuador in USD equivalent. Source: International Financial Statistics, International Monetary Fund.

Another false idea is that dollarisation is not viable if a fiscal deficit exists. This is a projection of the false conception that dollars have tiny legs that consistently take them out of the economy (something that happens only when people think the government will substitute them for devaluing pesos). People keep using their dollars inside the country but have them parked outside the country. In a dollarised economy, people trust the currency and save money inside the country. This was evident, for example, in 2008 when global liquidity diminished, as well as during the COVID-19 pandemic, creating conditions for dollars to escape back to the United States if they had tiny legs. Notably, none of the dollarised countries had any problem with their dollar liquidity.

As another example, trust in the dollar was proved in El Salvador when, after dollarising, the interest rate fell from 20% to 6% for mortgages, increasing their maturity from 5 to 25 years. Short-term loans also became cheaper. And this was not a fad. El Salvador’s inflation and interest rates have been among the lowest in Latin America for 22 years now. The interest rate in El Salvador has remained at these levels, with variations of one or two points, for more than 20 years, regardless of the fiscal deficit (it has been considerable in many years) and of international crises, including the 2008 crash and the COVID-19 event.

In the last two years, there was a scare that the government would not repay a large instalment of its long-term debt, and the EMBI (the difference between the yield of the Salvadoran bonds and the American ones) went up to almost 30% (see Figure 3). This indicates how the international secondary markets for sovereign debt consider the risks of lending to a government.

Figure 3: Interest rates in El Salvador: EMBI, 1-year loans and 25-year mortgages. Source: J.P. Morgan for EMBI, Central Bank of El Salvador for domestic interest rates.

Yet, in El Salvador, both short-term and mortgage interest rates remained around 7%, highlighting how the international markets (into which El Salvador is directly inserted, without intermediation by the central bank) assigned a considerably higher risk to the government compared to the private sector.

This does not happen in any other country in Latin America that is not dollarised. It happens only because the government cannot transfer its financial costs to the private sector by printing domestic money and devaluing it. As anybody knows, if the dollars had shown any preference to escape, the interest rates would have increased. They are the variable that keeps the equilibrium between dollars entering and leaving a dollarised economy.

This discussion could be prolonged, touching on many similar objections that project the defects of poorly managed local currency systems to a dollarised economy, a pattern observed in the history of the Argentine system. It is enough to say that Panama has worked with the dollar for over a century, and Ecuador and El Salvador for over 20 years.

The Madness of Milei

While dollarisation is not a bad idea, some of Milei’s more radical policies are dangerous and position the state as the enemy to be eliminated. Milei’s ideas develop the concept that everything should be settled in the market, buying and selling, that everything should be for sale. There are many examples of why this is a bad idea but let’s focus on two: education and health.

If free and compulsory education was eliminated the state would be giving one societal group (parents) the ability to take away from another group (their children) the opportunity to exercise their freedom as dignified and educated human beings at a time when the knowledge economy is dominating. Milei, who claims to be a freak of freedom, is proposing to take away degrees of freedom and choice from the Argentine society of the future, which would be restricted to choose between the limited options that ignorance gives.

And it’s not true that what happens to that child is no one else’s business. Living in a society of ignoramuses is extremely costly for all, including the ignorant. That is the basis of underdevelopment. The same can be said with regard to public health. Living in a sick society is dangerous for everyone. The poor will never have money to ensure good education and health, and that will keep them and the country poor.

Like all extremisms, that of anarchism is a madness that either cannot be implemented or would lead to the collapse of society if it could. If the media wants to find madness in the Argentine presidential campaign, they should look for it in those who propose to keep in place the power of the state to create money and, in Mieli’s conception of the state as the enemy that needs to be eliminated.

As the liberal philosopher Karl Popper wrote: “Liberalism and state interference are not opposed to each other. On the contrary, any kind of freedom is clearly impossible unless guaranteed by the state … Only a state controlled by free citizens can offer them any reasonable security at all.”

What is needed is to monitor the state, not delete it.

About the Author

Manuel Hinds
Manuel Hinds
Manuel Hinds has served as minister of the economy (in 1979) and of finance (in 1995-1999) in El Salvador, as division chief at the World Bank (in the 1980s and early 1990s), working with more than thirty countries, and as the Whitney H. Shepardson fellow at the Council on Foreign Relations in New York (in 2004-2005). He is the author of The Triumph of the Flexible Society: The Connectivity Revolution and Resistance to Change, Playing Monopoly with the Devil: Dollarization and Domestic Currencies in Developing Countries, and In Defense of Liberal Democracy: What We Need to Do to Heal a Divided America, and co-author of Money, Markets, and Sovereignty, with Benn Steil. He shared with him the 2010 Manhattan Institute´s Hayek Prize.
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