Buenos Aires — Dollarizing the Argentine economy “may sound attractive”, but “it is not the answer to the country’s problems”, according to Mark Sobel, the US chair of the Official Monetary and Financial Institutions Forum (OMFIF), and a former US Treasury Department official and US representative on the board of the International Monetary Fund (IMF) between 2015 and 2018.
In a warning to Argentine presidential candidate Javier Milei, who has said he would dollarize the economy if he were to win the August 22 elections, as well as close the central bank, Sobel said “Milei is right to call for fiscal consolidation” but considers that “dollarization would be too risky a bet”.
In a text published on the website of the Official Monetary and Financial Institutions Forum (OMFIF), of which Sobel is the US chair, he analyzes the economic situation that the country is going through and refers to why he believes that the dollarization that Javier Milei seeks to implement “is not the answer”.
“There is no silver bullet for the country’s problems, only hard work,” Sobel writes.
For Sobel, who chairs OMFIF in the United States, “Milei is right to call for massive fiscal consolidation to curb excessive indebtedness and liberalize the economy to boost productivity”.
In this regard, he recalled that the country has long suffered from cycles of overspending in a context of low savings. “This cycle is evident again in the current disastrous economic conditions.
“Excess domestic borrowing is financed by the central bank, causing high or hyperinflation. Large-scale external borrowing becomes unsustainable, resulting in serial defaults. Capital controls and multiple exchange rate practices further undermine competitiveness,” according to Sobel.
“These are fundamental problems that fiscal, monetary and structural policies must fix.”
“The Argentine economy is already significantly dollarised as there is little trust in the peso, and full dollarisation doesn’t seem a step too far. Discretion would be removed from the hands of officials, given their history of failure. Dollarisation in principle requires the government to bite the fiscal bullet and ensure that monetary financing is no longer provided. Inflation should in theory decrease sharply and sustainably with the country’s credibility tied to US monetary policy.
But dollarisation is a potentially perilous ‘no exit’ strategy. It could sow the seeds for a huge contraction and crash, while deflecting attention from the tough work of fixing the economy.
Under dollarization, Argentina’s growth will depend on running a current account surplus and generating capital inflow. That may be feasible with strong global growth, high commodity prices, attractive investments, sound rule of law and an undervalued currency,” Sobel writes.
He adds that Argentina’s experience in the 1990s and early 2000s “provides an extreme cautionary tale”.
“Under the convertibility plan, impressive strides were made in the 1990s in breaking the back of hyperinflation and restoring growth. But over the decade, fiscal deficits and debt weren’t reined in. Especially given the Mexican and Asian crises and then the 1999 Brazilian crisis, as well as a strong dollar and plummeting commodity prices, Argentina lost external competitiveness. Growth collapsed while unemployment and the current account deficit soared.
Argentina was unable to finance its external deficits and lost market access. Given large dollar-denominated external liabilities, investors sold Argentine paper, interest rates soared unsustainably, heavy capital controls were imposed and the convertibility plan collapsed amid huge economic, social and political dislocation.
The convertibility plan was a currency board, not full dollarization. Nonetheless, while proving beneficial for Argentine inflation, it wasn’t sufficiently buttressed by supportive macroeconomic policies and lacked resilience in the face of shocks, strongly contributing to a lack of sustainability and growth collapse. Dollarisation would face the very same challenges and risks,” Sobel writes.
‘Huge technical issues’
Sobel also points out that, while dollars are needed to back dollarization, Argentine net reserves are currently negative.
“The financial authorities significantly lose any ability to act as a lender of last resort, which can only heighten the vulnerability of the financial system. The links between the Argentine and US economies are small.
Argentina needs sweeping fiscal consolidation to stop the perpetual cycle of excess borrowing, high and hyperinflation, default and instability. It needs to slam the brakes on reserve money creation. As painful as this will be, it’s necessary for achieving sustainability and a transition to a better future. Argentina also needs extensive and sequenced liberalisation – it is not served by multiple exchange rates, capital controls and other restrictions. Strong banks are imperative,” he writes, adding that “that is the hard work that needs to be done”.
“A stabilization based on dollarization might more quickly reduce inflation than just biting the fiscal bullet, stopping credit creation and retaining currency flexibility. But the lack of an exit policy for dollarisation could well lead to a far more serious economic contraction and collapse, as happened in the aftermath of the convertibility plan, than with preserving a role for currency flexibility. In any case, macroeconomic and currency stability will not be achieved by simply introducing a new monetary regime. Rather, stability can only be achieved by actually doing the hard work.
Given Argentina’s sad economic history, one can be highly sceptical that officials will muster the political will to take responsibility and do the hard work, rather than blaming the International Monetary Fund for the country’s woes. Perhaps an optimist could summon up the courage to believe this time is different. The Argentine people deserve more than just excellence on the football pitch,” he concludes.