Among the promises of Argentina’s new president, Javier Milei, are to close the central bank and abandon the peso. So, could Argentina really close its central bank and abandon the peso and switch to the dollar?
In the second round of elections in Argentina, right-liberal Javier Milei was elected as the country’s new president yesterday with 56 percent of the votes.
Thus, a radical right-wing politician will govern Argentina, whose economy is in a very difficult situation due to triple-digit inflation, increasing poverty and the upcoming recession, for 4 years.
In his speech after the results, Milei said, “We are facing huge problems such as inflation, unemployment and poverty. “The situation is critical, there is no longer any room for small, insufficient measures,” he said.
HE PROMISED ‘SHOCK TREATMENT’
Considering applying “shock therapy” to the economy, Milei’s promises include closing the central bank, abandoning the peso, reducing public expenditures and economic reforms.
So can Argentina really close its central bank and abandon the peso and switch to the dollar?
First of all, it is useful to look at the outlook of the Argentinian economy.
OUTLOOK OF ARGENTINA’S ECONOMY
In the country where 4 out of every 10 citizens live in poverty, annual inflation has reached 143 percent as of October. Economists’ year-end inflation expectation is 185 percent.
Due to high inflation, the Central Bank of Argentina increased its benchmark interest rate to 133 percent. Although this situation encourages peso savings, it negatively affects access to credit and economic growth. Therefore, an economic recession is expected in the country. A 2 percent contraction is expected this year, also due to the effect of drought.
The country also has very strict capital controls to prevent flight to foreign currency. Currently, 4 different exchange rates are applied. While Milei has promised to quickly roll back capital controls and eventually dollarize the economy, a sharp devaluation is likely in the near future to bring the official and parallel exchange rates closer together.
IS DOLLARIZATION POSSIBLE?
The economic promises of Milei, who ran for president with the promise of ‘destroying the status quo’, were based on his desire to dollarize the Argentinian economy. Dollarization is the country’s abandonment of the Argentine peso as its currency. USA It means using your dollar.
Ecuador and El Salvador had also previously dollarized their economies to combat inflation. But no country the size of Argentina has ever handed over the reins of its own monetary policy to policymakers in Washington.
Milei’s proposal to change Argentina’s currency from the peso to the US dollar is based on the argument that the dollar is stronger than the peso and, unlike the peso, cannot be printed at will, thus reducing inflation, which increases through the money supply.
SURRENDER OF NATIONAL SOVEREIGNTY
Dollarization also causes a country to lose its autonomy to influence the economy through monetary policy moves such as interest rate changes. Milei’s opponent in the second round, Sergio Massa, criticized the dollarization plan as a surrender of national sovereignty.
The Cato Institute, a US-based liberal think tank, supports this move as a practical strategy to control economic problems that have been going on for decades.
Institute’s Latin America “Dollarization is the best tool available to quickly and permanently reduce inflation to single digits,” said policy analyst Daniel Raisbeck in his analysis after the election. Acceptance of the dollar as legal tender, local currency dollar “It also protects the purchasing power of citizens by making it impossible for it to lose value against the market.”
On the other hand, Milei’s party does not currently control Congress. It seems likely that the party will form a coalition with the centre-right party Juntos por el Cambio. For this reason, it is considered very difficult for some of Milei’s extremely radical plans to be approved by the congress.
Additionally, there are serious economic challenges to dollarization. If such a situation were to occur, the Central Bank of Argentina would need sufficient dollar reserves not only to purchase all the currencies in circulation, but also to provide banks with a reliable buffer to deal with a possible increase in withdrawals.
According to analysts, the country’s foreign exchange reserves are approximately 50 billion dollars below the amount required for dollarization. The country could try to fill this gap by raising money from foreign investors in the bond market and weakening the official exchange rate.
On the other hand, it is an extremely controversial view that the most important source of inflation is money supply and public expenditures. Although there is more than one reason for inflation, there have recently been serious studies showing that one of the most important sources of inflation is the ultra-profits of companies.
IT WILL LOSE INDEPENDENT MONETARY POLICY
The biggest problem with dollarization is the loss of an independent monetary policy. Countries that adopt the dollar are unable to adjust interest rates to regulate the money supply in response to changing economic conditions. Because this function is transferred to the US Federal Reserve, which determines interest rates according to the needs of the US economy.
For example, currently, the Argentinian economy is expected to shrink by 2 percent in 2023, while the Fed continues its tight monetary policy to combat inflation. While a looser monetary policy is expected to intervene in the shrinking economy under normal circumstances, the US remains dependent on the Fed because its priorities are different.
US Treasury officials have traditionally advised countries considering dollarization that it is not a substitute for sound macroeconomic policies, including responsible fiscal management.