The Argentine peso has a troubled past, but it might be about to face its greatest challenge. Free-market radical and populist candidate Javier Milei, who won 30% of the votes in Argentina’s primary election, has said he would abolish Argentina’s central bank and its domestic currency if he were to win October’s presidential election.
Treasury solutions firm Kyriba’s first-quarter currency-impact report identified the Argentine peso as the most volatile of the G20 currencies over the first three months of the year. Its official rate dropped almost 18% on news of the primary results.
Supporters of Argentine dollarization point to Ecuador, which adopted the dollar in 2000. Some observers have described the decision to scrap the sucre and the central bank there as the most successful monetary policy in Ecuador’s history, depriving governments of the possibility to overspend and giving ordinary people control of their money.
Following a visit to the country to attend a conference on 20 years of dollarization, Nicolás Cachanosky, associate professor of economics and director of the Center for Free Enterprise at University of Texas and senior fellow at the American Institute of Economic Research, noted that dollarization largely eliminates domestic shocks that would otherwise come from the politicization of monetary policy.
“One can certainly imagine a well-functioning central bank that would work better for Ecuador than dollarization,” he wrote. “But our ability to imagine such an institution does not at all imply it is likely to result. Abandoning the dollar risks getting stuck with a central bank a la Argentina, not with the ideal and efficient central bank the advocates of the sucre imagine they will get.”
Exciting agenda
Milei’s proposed approach to Argentina’s currency crisis has garnered support beyond anarcho-capitalist and libertarian fanboys. In a teaser for his new podcast ‘What’s ahead’, chairman and editor-in-chief of Forbes Media, Steve Forbes called it “one of the most exciting agendas in modern times”.
José Torres, senior economist at Interactive Brokers, says: “The adoption of the US dollar would help to stabilize the country’s economy over the medium to long term because it would prevent it from funding deficits by printing more currency while limiting its ability to issue debt.”
The adoption of the US dollar would help to stabilize the country’s economy long term because it would prevent it from funding deficits by printing more currency
José Torres, Interactive Brokers
In the short term, the sharp cut back in government spending would send the economy into a state of high turmoil, including a big drop in GDP. The hope is that pro-growth policies in combination with dollarization would create a sharp and sustainable recovery without inflation.
But if Argentina gave up its monetary policy, entered recession and needed lower interest rates at a time when the US was growing strongly and the US Federal Reserve was hiking rates, Argentine interest rates would also rise.
Dirk Willer, global head of macro and emerging market strategy at Citi, says: “When these things happen, it can lay the groundwork for a speculative attack on the currency as the market understands that the high interest rates from the US are not sustainable in Argentina if it goes into a recession.
“Even without a speculative attack on the currency, there still is a price to pay as higher than necessary rates would make any recession deeper.”
Another short-term challenge is that a credible peg depends on having deep enough FX reserves – something Argentina does not have.
“The market fears that the peso has to weaken more than foreseen, given talk of some form of peg,” adds Willer.
Dollar burden
In the past, the Argentine government has resorted to pegging to the dollar to obtain international financing at lower interest rates. This ended abruptly when a rising dollar in the early 21st century became too much of a burden on the economy and led to a series of defaults, the adverse effects of which Argentina is still living with.
Increasing the amount of dollars in circulation in the Argentine economy risks repeating past mistakes by placing a dollar burden on businesses and households, says Alexander Kuptsikevich, senior analyst at FXPro.
“Dollarization would dramatically reduce inflation, bringing it closer to the dollar zone,” he says. “However, the economy would have to adapt by adjusting wages, taking over the shock absorber role of the market exchange rate. Without this mechanism, the country’s foreign trade would be under attack.”
Dollarisation would dramatically reduce inflation, bringing it closer to the dollar zone. However, the economy would have to adapt by adjusting wages, taking over the shock absorber role of the market exchange rate
Alexander Kuptsikevich, FXPro
Given how quickly inflation has accelerated and the peso has depreciated this year, adoption of the dollar could look like an appealing solution. But the challenges to making such a shift are both systemic and structural in nature, explains John Kicklighter, head of global content at StoneX.
“In addition to ceding the ability to pursue active and independent monetary policy, making such a shift as a panic response highlights the significant diminishment of local policymakers’ ability to act as a lender of last resort in their own financial system,” he says.
Torres at Interactive acknowledges that elected officials would have to accept short-term economic turmoil in order to work toward longer-term economic stability, including embracing unpopular government spending cuts.
“The public may provide pushback when the government seeks to balance its budget by scaling back or eliminating certain government programmes and laying off public-sector workers,” he says. “Additionally, the decline in GDP from curtailing government spending would result in considerable job losses in the private sector.
“However, a sharp economic recovery fuelled by dollarization and pro-growth policies could temper the mood among both elected officials and citizens, with stronger economic conditions pushing them to support the plan.”
Of course, Milei hasn’t won the vote yet, and even the most disillusioned Argentines may ultimately reject a candidate whose other wheezes include making it legal to buy and sell human organs. One of his political allies also admitted this week that the process of dollarization could take up to two years, which is a lifetime in politics.
But in a country where the value of the currency can shift discernibly in the time it takes to read an article on its floundering economy, the desire to change may be enough to make it the largest nation to hitch its fiscal wagon to the greenback.
