Can Argentina dollarize?

Observatorio argentino 54: La dolarización

The Argentine primary elections went pretty well for Javier Milei and his Liberty Party.¹ Which means that we need to talk about dollarization. By which I don’t mean talking about whether it is a good idea.²

Milei has proposed two sorts of dollarization. In one, the national government makes the U.S. dollar into a second legal tender. In the other, the country gets rid of the peso. The first option strikes me as little more than a way for a future Milei administration to weasel out of its dollarization promise. Many large transactions in Argentina are already denominated in dollars. It would be a change for the government to accept dollars for tax payments — but who would want to pay taxes in dollars if you could pay in pesos instead? Maybe I’m missing some interesting subtleties, but I’m just going to leave that one alone.

So can Argentine adopt the dollar? Well, let’s first look a country that could easily adopt a foreign currency: Denmark. Here is the balance sheet of the Danish central bank:

Honestly, the unit on the y-axis really doesn’t matter.

The Danmarks Nationalbank has foreign exchange reserves well in excess of both the number of kroner in physical circulation (the orange block) and the value of the bank deposits held at the central bank (the light blue block). All the government would need to do is order the central bank to redenominate the blue assets into euros or dollars or shekels or reales or whatever and convert enough of its foreign assets into physical cash to exchange the notes and coins. Easy peasy.

The balance sheet of the Banco Central de la República Argentina does not look like this.

Now, this is at the pre-election official exchange rate of 283 pesos per dollar. It would be a terrible idea for Argentina to try dollarizing at the official rate. So let’s revalue the balance sheet at the current black market—called the “blue market” in Argentina, for the color of the marker used to verify Benjamin Franklins—rate of 685 pesos per dollar.

It looks a little better, but there is that pesky issue of the “banks’ net position.” Let’s unpack what that is.

It isn’t simple deposits at the BCRA, although I’m not sure it would make any difference if they were. Rather, they are short term bonds that the BCRA sells to the banks. Argentine banks don’t make many loans; they mostly sit on the cash deposited into them. But if banks sit on cash, then they don’t earn interest. If they don’t earn interest for themselves, then they can’t pay interest to depositors. In a country where inflation has been in double-digits for years (now triple digits), nobody will want to deposit their money in a bank that doesn’t pay interest—no, you’ll either spend everything you have as fast as you can or turn it into dollar assets! But if everybody pulled their money from the banks, then the banks would collapse.

Let me run through that again, this time as a list:

1. Argentine banks don’t loan out most of their deposits, because the Argentine economy is all scary;

2. But if the banks don’t make loans, then they can’t earn interest;

3. If they don’t earn interest, then depositors will pull all their money and the banks will collapse;

4. So the central bank gives them a safe interest-bearing instrument to park their money in. The interest doesn’t usually beat inflation, but it is enough to stave off collapse.

The central bank pays these things off by printing pesos.

If Argentina dollarizes, then it will have to pay these things off in dollars. But the BCRA doesn’t have enough dollars to do that. So what are the options?

1. Get a foreign loan. Good luck.

2. Let the peso crash to a level low enough right before dollarization that the BCRA can cover the outstanding debt before the Milei administration abolishes it. That’s an option, albeit a pretty painful and chaotic one.

3. Default on the debt and let the banks sort it out. That would be even more chaotic than option (2).

4. Dump its holdings of government securities and use the proceeds to pay off the debt. That could work—but dumping government bonds will lower their prices and raise interest rates. (And do remember that the Argentine government will still have to borrow, even with Milei working his magic.)

5. Convert the debt into long-term government bonds. See (1), above. Who is going to finance the conversion? And you’ll be adding to the debt burden of a government which already is having no small trouble making its payments.

Honestly, none of those look all that good. If I were a betting man, then I would bet on number (2). Which explains the big drop in the peso after the PASO.

TLDR: regardless of the medium and long-term merits, dollarization will involve a lot of short-term pain. Plan a trip to Argentina now to enjoy the rock-bottom prices, stay for the riots and tear gas!

The calm before the storm?

There are also political obstacles. If Milei makes it to the Pink House (pictured above behind the beautiful woman) then he will need to either convince or circumvent three other actors to make dollarization happen: Congress, the IMF, and the People’s Republic of China.³

The next post will discuss those obstacles and what overcoming them might entail.

1. Technically, it’s the “Liberty Advances!” party. But that just sounds too stupid to my 20th-century ears.

2. I think any fair observer would have to say that the jury is out. Dollarization hasn’t been disastrous, but it also hasn’t creating any economic miracles. The euro, as we know, has not been good for Greece, although we don’t know the counterfactual. Dollarization also looks like a one-way street. Greek voters have never been able to bring themselves to just ditch the euro and Zimbabwe has tried and failed to de-dollarize. Liberia de-dollarized in the 1980s in the context of a massive civil war. “Successful” introductions of new currencies have really only occurred in the context of hyperinflating union currencies (the Soviet Union, the Austro-Hungarian Empire) or with the extensive cooperation of the government in control of note issue.

3. No, not the United States. We could help Argentina dollarize, but we don’t have a veto point, except via our power over the IMF. Which isn’t nothing!