‘For every complex problem there is an answer that is clear, simple and wrong.’*
With Javier Milei’s ‘surprise’ victory in Argentina’s primary election, global investors are now focusing on his highly unorthodox economic policy proposals for strong fiscal austerity, liberalisation and dollarisation – and, by extension, abolishing the central bank.
No matter who wins the presidency, Milei is right to call for massive fiscal consolidation to stop excess borrowing and to liberalise the economy to bolster productivity. But dollarisation would be a far too risky gamble. There is no silver bullet for the country’s problems, only hard work.
Argentina has long been plagued by cycles of excessive spending against the background of low savings. This cycle is evident again in the current disastrous economic conditions. Excess domestic borrowing is financed by the central bank, causing high or hyperinflation. Large-scale external borrowing becomes unsustainable, resulting in serial defaults. Capital controls and multiple exchange rate practices further undermine competitiveness.
These are fundamental problems that fiscal, monetary and structural policies must fix.
Dollarising the economy is appealing on the surface
The Argentine economy is already significantly dollarised as there is little trust in the peso, and full dollarisation doesn’t seem a step too far. Discretion would be removed from the hands of officials, given their history of failure. Dollarisation in principle requires the government to bite the fiscal bullet and ensure that monetary financing is no longer provided. Inflation should in theory decrease sharply and sustainably with the country’s credibility tied to US monetary policy.
But dollarisation is a potentially perilous ‘no exit’ strategy. It could sow the seeds for a huge contraction and crash, while deflecting attention from the tough work of fixing the economy.
Under dollarisation, Argentina’s growth will depend on running a current account surplus and generating capital inflow. That may be feasible with strong global growth, high commodity prices, attractive investments, sound rule of law and an undervalued currency.
But Argentina’s experience in the 1990s and early 2000s provides an extreme cautionary tale. Under the convertibility plan, impressive strides were made in the 1990s in breaking the back of hyperinflation and restoring growth. But over the decade, fiscal deficits and debt weren’t reined in. Especially given the Mexican and Asian crises and then the 1999 Brazilian crisis, as well as a strong dollar and plummeting commodity prices, Argentina lost external competitiveness. Growth collapsed while unemployment and the current account deficit soared.
Argentina was unable to finance its external deficits and lost market access. Given large dollar-denominated external liabilities, investors sold Argentine paper, interest rates soared unsustainably, heavy capital controls were imposed and the convertibility plan collapsed amid huge economic, social and political dislocation.
The convertibility plan was a currency board, not full dollarisation. Nonetheless, while proving beneficial for Argentine inflation, it wasn’t sufficiently buttressed by supportive macroeconomic policies and lacked resilience in the face of shocks, strongly contributing to a lack of sustainability and growth collapse. Dollarisation would face the very same challenges and risks.
Huge technical issues are also associated with dollarisation
Dollars are needed to back dollarisation but Argentine net reserves are currently negative. The financial authorities significantly lose any ability to act as a lender of last resort, which can only heighten the vulnerability of the financial system. The links between the Argentine and US economies are small.
Argentina needs sweeping fiscal consolidation to stop the perpetual cycle of excess borrowing, high and hyperinflation, default and instability. It needs to slam the brakes on reserve money creation. As painful as this will be, it’s necessary for achieving sustainability and a transition to a better future. Argentina also needs extensive and sequenced liberalisation – it is not served by multiple exchange rates, capital controls and other restrictions. Strong banks are imperative.
That is the hard work that needs to be done.
A stabilisation based on dollarisation might more quickly reduce inflation than just biting the fiscal bullet, stopping credit creation and retaining currency flexibility. But the lack of an exit policy for dollarisation could well lead to a far more serious economic contraction and collapse, as happened in the aftermath of the convertibility plan, than with preserving a role for currency flexibility. In any case, macroeconomic and currency stability will not be achieved by simply introducing a new monetary regime. Rather, stability can only be achieved by actually doing the hard work.
Given Argentina’s sad economic history, one can be highly sceptical that officials will muster the political will to take responsibility and do the hard work, rather than blaming the International Monetary Fund for the country’s woes. Perhaps an optimist could summon up the courage to believe this time is different. The Argentine people deserve more than just excellence on the football pitch.
Mark Sobel is US Chair of OMFIF.
*Quote often ascribed to H L Mencken