A Response To Two Open Letters Opposing Dollarization In Argentina – OpEd

Elections bring out the silliness in everyone—economists are no exception. But when economists substitute their political ideas for economic analysis, the results are bad politics and bad economics. Such is the case with two recent open letters, signed by more than 300 economists, about the proposal of Argentine presidential candidate Javier Milei to scrap the Argentine peso and adopt the U.S. dollar as Argentina’s official currency.

The first open letter, “El espejismo de la dolarización” (The Trap of Dollarization), was issued in mid September and signed by more than 200 Argentine economists. The second, “The Dangers of Javier Milei’s Economic Program in Argentina,” was recently published by many news outlets for foreign consumption and signed by more than 100 economists, mostly non-Argentines. It was released just in time for Sunday’s final round of the presidential election. The letters are remarkable for their sloppy analysis.

Both letters acknowledge Argentina’s current biggest problem: Inflation, by my measure, is currently at 239 percent per year, which is significantly higher than Argentina’s official inflation measure of 142.7 percent per year. Neither letter identifies the cause of Argentina’s inflation: The Central Bank of the Argentine Republic (BCRA) is creating money (M3) at a rate of 115 percent per year, far in excess of the public’s demand. Consequently, neither letter presents a cure for Argentina’s endemic inflation.

Argentina has had a central bank since 1935. While many governments have tried to prevent it from falling under political influence and financing government spending by excessive creation of money, none of their schemes have worked in the long run. Most have failed even in the short run. From 2001 to the present, the peso has depreciated from 1 peso per dollar to a black-market rate of around 900 pesos per dollar currently, one of the worst performances in the world. To continue with the central bank is to continue with its long, dismal record.

Both letters claim that dollarization would involve a massive depreciation of the peso relative to the dollar because the central bank’s foreign reserves are low. On a net basis, they are probably negative because the central bank has more liabilities than assets in dollars and other foreign currencies.

But, the signatories of the letters possess a misunderstanding about how the foreign-exchange market works. Although the central bank’s foreign reserves are low, Argentines hold an estimated U.S. $265 billion in foreign bank deposits and cash, mainly in dollars. The public sector is starved for dollars because of mismanagement, but the private sector has an ample supply that would be more readily forthcoming under dollarization. If dollarization were to happen 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 about 900 pesos per dollar, which is kept high by the illegality of the transactions.

The letters criticize the idea that dollarization would force the government to balance or reduce the budget deficit to a level that markets would finance without inflation. So, what’s the problem? After all, that is exactly what happened in Ecuador when it dollarized in 2000. The country was experiencing inflation and government budget problems, similar to Argentina now, plus a banking crisis that resulted in a freeze on withdrawing deposits. The stability and confidence that dollarization created reduced the budget deficit from 4.6 percent of GDP in 1999 to 0.3 percent in 2000. Ecuador today has government spending similar to Argentina, at 38 percent of GDP, but its budget deficit is 1 percent of GDP, versus 4 percent for Argentina.

The letters also claim that, because Argentina’s economic cycles differ from those of the United States, it would be disadvantageous to tie Argentina to the dollar. Since 2000, the United States has had three recessions, totaling 28 months. Argentina has had eight recessions, including the current one, totaling 30 quarters, or 90 months, counting similarly to the way U.S. recessions are counted. It would help Argentina to stabilize and grow if it could converge with the U.S. frequency of recessions. If that isn’t bad enough, the signatories of the letters assume the improbable; namely, that the BCRA could moderate Argentina’s business cycles in ways that it has never been able to do.

The signatories also ignore the fact that the Argentine public has already voted to de facto dollarize. As mentioned above, Argentines hold an estimated U.S. $265 billion “under the mattress” and in foreign bank accounts. As much as it is legally possible, and even illegally if they can get away with it, Argentines prefer to transact in dollars. If Argentines were legally allowed to make all transactions in U.S. dollars, the peso would probably disappear from circulation in a matter of weeks. That’s exactly what happened when Montenegro allowed people to use the German mark freely in 1999. The local currency, the Serbian-Montenegrin dinar, disappeared from circulation. As a Montenegrin state counselor, I advised Montenegro’s former president Milo Dukanovic on “dollarization.” We successfully “dollarized” Montenegro with ease, and without needing any preconditions. Nearly a quarter-century later, Montenegro still enjoys monetary stability, now with the euro, which replaced the German mark. The people had a free choice in Montenegro. They should have the same in Argentina.

This article was also published in National Review