Javier Milei: Argentina's Inflation Challenge and Dollarization
Javier Gerardo Milei has positioned himself as a critic of traditional economic policies. He advocates for radical changes to address Argentina’s economic woes, particularly focusing on the high inflation rates that have plagued the country, that have been a persistent challenge, undermining economic stability and eroding the purchasing power of the Argentine peso. In recent years, inflation has contributed to economic uncertainty and social unrest.
Milei’s economic policy centers on deregulation, free markets, and fiscal responsibility. He argues for reducing government intervention, fostering free-market competition, and controlling government spending to mitigate inflationary pressures.
Currency stability is a key component of Milei’s proposals, advocating for a stable currency and potential changes to the monetary framework to address inflation. He also emphasizes the need for significant public sector reforms to streamline bureaucracy and reduce the burden on public finances.
As summarized by The Economist “a century ago, Argentina was one of the wealthiest countries in the world; today, it is synonymous with crisis. The economy has been poorly managed under both left and right-wing administrations, with an annual inflation rate of 138%, the third highest in the world. The percentage of people who cannot afford basic groceries or essential services such as transportation or healthcare has risen from 26% in 2017 to 40% today. Argentina owes the International Monetary Fund the staggering sum of $44 billion – nearly a third of the Fund’s entire loan portfolio – but the country’s central bank lacks dollar reserves to repay the loan. Corruption is rampant, trust in institutions is low, and voters are exhausted.”
One of the reforms that the new president promised to the nation is dollarization, one of the main themes of his electoral campaign. This consists of removing the Argentine peso from circulation, abolishing the central bank, and effectively using the United States currency as the national currency, therefore, eliminating monetary sovereignty and essentially becoming dependent on the United States for currency matters.
While dollarization is not unprecedented, with countries like Ecuador and El Salvador already adopting similar policies, Argentina’s significantly larger economic size and population, coupled with its precarious economic situation, magnify the potential risks and consequences.
The idea of dollarization isn’t new to Argentina; it was first proposed and debated back in 1990 and has since been the subject of numerous theoretical and empirical studies. One notable analysis by experts from the International Monetary Fund, Andrew Berg and Eduardo Borensztein, delves into the pros and cons of full dollarization. Their findings suggest that while dollarization may mitigate the risk of sudden and severe devaluation, it requires a nation to have sufficient dollar reserves to initiate the transition—a challenging feat for Argentina given its depleted central bank reserves due to past economic mismanagement.
«Its main attraction – explain the two experts – is to eliminate the risk of a sudden and heavy devaluation. This can reduce the risk premium a country must pay to international creditors.
Dollarized economies can enjoy a greater level of confidence among foreign investors, reduce debt service, stimulate investment and growth. In the case of Argentina, the main obstacle to dollarization is the initial leap. To remove the peso from circulation and replace it with the dollar, a nation must be able to buy dollars. It seems obvious, but the problem in Buenos Aires is that the disastrous economic management of previous governments has almost wiped out its central bank’s reserves, so it is not clear with what resources the new president could obtain the initial liquidity in dollars. The proposed privatizations may offer a source of revenue, but their actual value remains uncertain.
An indirect objective of dollarization presents similarities with what Italy (along with other European countries) did when it abandoned the lira to switch to the euro in 1999-2002, although it is important to underline that the differences are substantial. The implications of relinquishing monetary sovereignty extend beyond economic considerations. Unlike the European Union’s model of monetary union, where member states share control over monetary policy through a centralized institution, dollarization entails ceding control to the United States Federal Reserve, which operates solely in the interest of the US economy. This shift could potentially exacerbate Argentina’s economic vulnerabilities and limit its ability to address domestic challenges effectively.
The Federal Reserve, the US central bank, will not consider the economic situation in Argentina (or Ecuador, or Zimbabwe), it will continue to make its decisions in the interests of the United States.
Similarities with the euro can be found in the hope, that by depriving a country of the “freedom” to devalue, the country is also forced to regulate its behavior: that it must therefore control its production costs rigorously in order not to lose competitiveness. We know that the myth of the “external constraint” has not given all the expected results in Italy. For Argentina, the abolition of the peso is unlikely to be enough to force the country to reduce unproductive public spending or wild labor conflict. Peronism – the local form of socialism and welfarism – has roots in the habits of vast social categories. Milei won the presidency but does not have a parliamentary majority nor a majority of local governors.
Internationally, Argentina’s embrace of dollarization may have broader geopolitical ramifications. Argentina had been admitted to the BRICS, the group of emerging countries which originally includes Brazil, Russia, India, China, South Africa. The enlargement of the Brics, decided at the August summit in South Africa, was promoted above all by Xi Jinping who hopes to transform that alliance into a marked opposition to the United States. Both Xi Jinping and Lula are campaigning to reduce the weight of the dollar in the world economy. And now they find themselves with a new pro-US Argentine leader, who wants the dollar as his country’s currency. Perhaps, China and Brazil may reconsider their strategy.
In essence, while the prospect of dollarization may offer short-term stability, its long-term consequences and the challenges associated with implementation underscore the need for careful deliberation and comprehensive planning. As Argentina contemplates this bold economic maneuver, it must weigh the potential benefits against the inherent risks and consider its implications within the broader global context.
