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The effect of US dollarization on Argentina’s fragile and debt ridden economy

Argentina’s new president has stated his intention to dolarize the Argentine economy. How would this impact the US dollar’s exchange rate?

Update:
Argentine president-elect Javier Milei addresses supporters after winning Argentina's runoff presidential election, in Buenos Aires, Argentina November 19, 2023. REUTERS/Agustin Marcarian
AGUSTIN MARCARIANREUTERS

Javier Milei, a far-right and self-proclaimed anarcho-capitalist, has been elected as the new president of Argentina. The country has been experiencing an economic crisis for some time now, worsened by an inflation rate that has surpassed 100 percent. With the central bank almost out of US dollars to pay its debts, the population is in urgent need of protection from another economic disaster.

How would dollarization impact the Argentine economy?

One of Milei’s proposed solutions to stabilize the economy is to replace the Argentine Peso with the US dollar. While Milei believes that this move would help limit inflation, it would also mean that the country would have no control over its currency and be at the mercy of the US Federal Reserve. Economists have warned that the Central Bank of Argentina doesn’t have sufficient dollars to enable a smooth transition to a dollarized economy. In order to make the transition, the country may need to take on additional debt from the International Monetary Fund (IMF) to facilitate this process.

The Federal Reserve of Chicago has reported that the “Argentine economy is already partly dollarized [...with] 60 percent of private non-financial sector deposits are [being] dollars.” Because of the wide use and circulation of dollars, the Fed assumes that the change “would not dramatically” alter the “habits and practices” of the public. While for the average person, there may not be many changes in the short-term, officials in the country would have far less power over their economy at a policy level, with their central bank taking directives from the Federal Reserve.

Looking at the longer-term impacts of dollarization, the public could begin to feel that lack of sovereignty, particularly if any debt taken on to dollarize is conditional on cuts to social spending on education or public health. The Economist has argued that rather than dollarizing, Argentina should default on its debts as it becomes evident that they do not have the resources to continue making payments. Such a move may still require debt restructuring with the IMF that could threaten social programs upon which many Argentines depend.

Yanis Varoufakis, the former Finance Minister of Greece, compared dollarization to “nuking a country to get rid of covid-19.” The former-minister is not alone in his skepticism that dollarization and further dependence on the IMF will solve Argentina’s economic problems.

However, to fully understand the impact that dollarization could have, it is crucial to examine how Argentina ended up in this current crisis.

Argentina’s tenuous relationship with the International Monetary Fund

Argentina’s $403 billion debt is difficult to pay due to record-high inflation and an economy that is bleeding deposits. IMF Managing Director Kristalina Georgieva took to X to congratulate Milei, noting the need to collaborate to “develop and implement a strong plan to safeguard macroeconomic stability and strengthen inclusive growth for all Argentinians.”

Nobel Prize-winning economist Joseph E. Stiglitz explained the detrimental impact the last IMF restructuring had on the Latin American economy. These past experience leave skeptics of the IMF weary that additional intervention by the international organization is the key to the country’s economic woes.

In 2018, the IMF required Argentina to lower its national budget by 4.4 percent of GDP by 2020. Stiglitz says that the decision was made by the IMF to “restore market confidence.” However, as the economist goes on to explain, “it had the opposite effect.” The IMF was aware that the economy had begun to shrink and “doubled down and opted for even more fiscal and monetary tightening.” The IMF officials made projections of growth, but on the ground, poverty increased by fifty percent, and the economy fell into a recession.

The Argentinian economy is currently experiencing a devastating situation, and several underlying problems are causing it. However, we cannot afford to overlook the effect that the IMF has had on the economy, especially since the organization, as hinted by Ms. Georgieva’s recent comments, is expected to be involved in any economic plan that the country may adopt.

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