Dollarisation in Argentina: Allure, risks, and unintended consequences

Questions remain as to whether a 'dollarised' Argentina would fit into BRICS

Argentina Elections Social organisations and leftwing parties marched against the rise of Argentina's right-wing populist presidential candidate Javier Milei, and the government's economic adjustment policies, at Plaza de Mayo, Buenos Aires | AP

For inflation-weary Argentines, dollarisation holds an alluring promise - simply adopt the dollar as legal tender, close the central bank, and enjoy American-style prosperity. The appeal is understandable, given the tumultuous economy. 

The reason for American prosperity is clear: The dollar and its use as the world’s reserve currency. Americans live lavishly at nearly twice the rate of Europeans, and the new Argentinian dream is for dollarisation to transport the country to the lavish standard of living enjoyed by even poor Americans. 

But dollarisation is no panacea and could backfire disastrously without proper foundations.  

Relative to the rest of the world, Americans enjoy the highest standard of living even the bottom 20 percent have a higher level of consumption than citizens in most wealthy nations. The U.S. benefits from strong institutions, investment inflows, and prudent policies that Argentina sorely lacks after decades of volatility.

So, Argentinians could be forgiven for believing that closing the central bank, abandoning their currency and dollarising the economy would end the financially turbulent times and put them on easy street. They could soon be proven wrong.

They have been following Javier Milei, a right-wing populist with a throwback Elvis-cum-Boris-Johnson hairstyle who has tapped into inflation fatigue and tells them that, if elected president, he would eliminate the central bank and make the dollar legal tender in Argentina.

With inflation expected to reach 169 percent by the end of the year and reaching its largest month-to-month increase in 32 years this August, the political climate on the ground in Argentina today is similar to the conditions in Brazil in 2018 that had a population rejecting Lula's PT leftist party and its politics and so ended up electing the far-right nationalist Jair Bolsonaro.

For Argentina, it would be a wild swing back to the right after the leftist government of Alberto Fernandez, whose government itself was an extreme reversal of his right-wing predecessor Mauricio Macri.

Political polarisation is an old problem in Argentina. It is locally known as as la grieta, or the gap, which often leads to severe policy reversals whenever a new administration takes power. With inflation sky high and the public tired of Kirscherism, the right-wing Milei seems primed to replace the leftist Fernandez. 

Like Bolsonaro and Trump, Milei is a neoliberalist promoting free-market capitalism, deregulation, globalisation and trickle-down economics. He vows to stop the high inflation and parallel exchange rates through dollarisation and says the measure will make Argentina into "a world economic power" in 35 years.

Elon Musk jumped into the Argentinian elections providing a de-facto endorsement of Miliei by commenting on fired ultra right-wing FOX News commentator Tucker Carleson's interview of Miliei and attacking the government for "excessive spending." He had dipped a toe in those waters before, commenting and then erasing "It would be a good change" when Tucker first announced he would interview Milei. Tucker broadcasts on Musk's X platform, formerly Twitter.

Milei is favoured to win the October 22 elections.

But Argentinians may only have to look as far as Ecuador, El Salvador, or Panama to see the other side of the dollar coin. Ecuador dollarised its economy in 2000, adopting the US dollar as its official currency. The moment is now seen as a turning point that made Ecuador a haven for illicit cash and criminal networks, springing up a domestic drug industry that has plagued the country with violence.

In 2023, it has spilled onto the streets and has resulted in the assassination of political leaders and presidential candidates as security devolves into a criminal-turf battle. The unintended consequences of good intentions in Ecuador show the conundrum that Argentina may find itself in. 

Dollarisation aided growth but unwittingly abetted laundering which then begat drug trafficking as money launderers corrupted the power structure with bribes that eventually moved from dollars to drugs as payment.

In ditching its national currency in favor of the dollar, Ecuador lost restrictions and oversight of financial transactions. Inadvertently, the change allowed dirty money to freely flow into the banking system, with criminals hand-carrying suitcases of cash across Ecuador's porous borders with drug trafficking nations Peru and Colombia. 

Vast money laundering networks sprang up behind front businesses that justify deposits and transfers without actual trade. Today, torrents of illicit cash continue to flow unabated into the country's banks and the authorities have no effective control.

Ecuador's security climate illustrates dollarisation's Faustian bargain — economic success predicated on a loss of independence and control, which often translates to turning a blind eye to corrosive effects in order to preserve the economic gains. It boils down to no inflation, but with pervasive poverty subject to criminality and violence.

Does it have to be that way?

The answer lies in the mechanics of how money works at the global level, and what is the mirage of dollarisation that makes it so attractive. 

On the one hand, yes, Americans have a prosperity level built upon the dollar and a country merely using the US dollar as its own currency provides a useful illusion of the same level of prosperity. On the other hand, reality.

While the US can issue more of its own money and obtain low interest loans because the dollar is used as the world's reserve currency, and because that lubricates the economy making plenty of inexpensive capital available to Americans, a third country merely using the dollar as its currency does not have that independence. It cannot issue more money and it does not have access to those low interest loans the US uses regularly. 

In other words, economic freedom and prosperity is a privilege for the US but not for thee. The world subsidises the American economy but that is through the control of its money supply, which countries using the dollar do not have.

Ecuador is indeed a cautionary tale. But let's look at other aspects by observing Panama and El Salvador, both countries have been using the dollar for enough time now to gauge its effects on their overall economy.

Panama City is the shinning city on the isthmus' coast and the best argument for a dollar-based economy. But take a 45-minute drive north on the scenic Pan-American highway to Colon, Panama's second largest city, and just before the town of Sabanitas, you begin to see more and more rotting buildings, sewage in alleyways, and an obvious lack of running water. 

Colon is a city where dollarisation has not tricked down much since Panama has been 1:1 parity with the dollar since 1904 (the paper US dollar is its only currency, though the country duplicates American coins in size, shape, weight, and value for local use, the Bilbao exists only notionally). Crime and poverty are as prevalent as hopelessness. Like in Ecuador, a drug trafficking mafia and cartels run the city.

Argentina has more than 10 times the population of Panama, underscoring the difficulty of the challenge it would face.

In El Salvador, dollarisation has had mixed effects on the country's money laundering problem. While dollarisation has reduced currency risk and generated substantial savings for the country, it has also limited El Salvador's monetary policy independence. It has not improved economic development but has made the country even more vulnerable to money laundering and tax evasion. 

Seeking solutions, the government of Najib Bukele is now experimenting with the adoption of Bitcoin as legal tender. El Salvador has a population of 6.6 million; Argentina, some 40 million more.

A smattering of Caribbean and Pacific island nations and Zimbabwe use the dollar as their official currency. None of them have become economic powerhouses as Milei is promising Argentinians. 

The allure and risks of dollarising Argentina 

While curbing wild price swings and runaway inflation that have long plagued Argentina may prove an irresistible allure for Argentinians, the country likely lacks the hard currency reserves needed to back a credible dollar system. Most experts argue abrupt dollarisation could trigger deeper financial turmoil, at least initially.

Milei is proposing dollarising at the current blue chip swap rate of around 730 pesos per dollar, which critics call absurd. Let's compare to a similar situation in Ecuador in 2000 during dollarisation: The proposed swap rate was 25,000 sucres per dollar. Five days later, the government had "dollarised" people's savings at 37,000 sucres per dollar, effectively erasing 35 percent of their wealth. 

It was, however, a "magic" solution that had immediate positive effects. It is the mid- and long-term effects that may be the country's curse. "Don’t be fooled by these criminals," says Milei addressing warnings by economists about his plan. "Wages in dollars will rise a lot, bringing down poverty." 

"Sure, people earn more, but the cost of living is also higher," Guayaquil sociologist César Aizaga-Castro told THE WEEK. "Wages in Ecuador did start to rise with dollarisation, but so did the price of everything, at a higher pace," recalls Aizaga-Castro who says his family lost much of its savings in the transition period when the banking sector, with the support of the state, froze everyone's funds during an exchange period and then set a compulsive rate later.

For Argentina, the challenge may rest in finding a controlled way to dollarise without crashing the economy. The lure remains strong, but so do the risks.

To add a political dimension, Argentina has just been invited to join the BRICS bloc in January. BRICS has made its priority to de-dollarise the global economy as it integrates Global South economies. Would a Milei victory mean that the country may pass on its invitation and skip BRICS? Doing so may create as rift with Brazil’s Lula who has championed Argentinian admission into the platform.

Decades of volatility and mismanagement have left Argentina bereft of foundations deemed essential for dollarisation, like ample currency reserves, healthy banks, and robust institutions. Yet Milei brushes off these concerns, deriding cautious economists as "criminals."

Most experts agree that solid dollar reserves are essential to back a new currency system and inspire confidence. By some estimates, Argentina's central bank needs between $50 and $100 billion to defend a fixed exchange rate, far more than its current reserves estimated by some analysts at around $18 billion, far less by others. 

A sudden switch to the dollar sans reserves risks runaway inflation and financial meltdown, analysts warn.

Building such reserves would require Argentine leaders to enact fiscally disciplined policies focused on attracting foreign investment, such as reducing deficits, managing currency controls, and addressing distortions like high energy subsidies.

"Dollarisation requires strong institutions and rule of law. Ecuador shows how an unchecked dollar system can enable illicit finance. A sudden switch to the dollar sans reserves risks runaway inflation and financial meltdown," analysts warn.

"To ensure stability, Argentina needs robust regulation and governance of its financial system," German economist Christian Graf said while discussing the Argentinian proposal with THE WEEK. "Creating a healthy banking system and active capital markets will be critical to intermediating flows once dollarised," he said.

"None of this will be quick or easy after decades of volatility and institutional decay," added Graf. "But, for Argentina to realistically reap benefits like reduced inflation from dollarisation, building reserves, fixing banks, and fortifying institutions are key prerequisites first," he said.


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