The victory of Javier Milei in the primaries has put dollarization at the center of the public debate. The candidate has announced his intention to close the Central Bank of the Argentine Republic (BCRA, by its Spanish initials) and replace the peso with the dollar as legal tender. The proposal might sound attractive, because it promises to eliminate inflation and because our earnings would be in hard currency, but it leaves out a series of details on technical aspects and implementation that, all things considered, make the proposal unviable.
We economists have written much about the problems that dollarized economies face. One point often raised, for example, is that without a central bank, the financial system lacks a lender of last resort, and is therefore more fragile with a greater propensity for crisis. Another issue is that the economy is less flexible in the face of external shocks because it can’t devalue the currency when its production becomes more expensive in relation to its commercial partners. The agonizing economic depression in Greece, which has been going on for over a decade, is an example of this kind of problem.
We also know that dollarizing doesn’t guarantee fiscal responsibility, as the proponents of this scheme suggest. Rafael Correa’s Ecuador increased public spending from 21% of GDP to 44% of GDP in less than a decade, and suffered two sovereign debt defaults. All these elements make dollarization difficult to recommend — but I’d also advise against it because of the implementation problems it would imply if it were attempted in Argentina today.
Clash with the constitution
The elimination of the central bank and the national currency are highly likely to be considered unconstitutional. With regard to congress’s faculties, article 75 of our constitution establishes the institution of a central bank and a currency whose value must be protected. Regarding that article, Supreme Court President Horacio Rosatti expressed a little over a year ago that the constitution prohibits a change in currency.
Even if a legal loophole were found in order to dollarize, it is important to consider what the implementation would look like — and in particular, what exchange rate would be used to dollarize. This is calculated by establishing a relationship between the central bank’s peso liabilities and dollar assets. The two main peso liabilities are the monetary base and paid liabilities (leliqs and repo transactions). The main dollar assets are foreign-currency international reserves and the many forms of debt the National Treasury has with the central bank.
The accounting would also have to consider that there is a series of foreign-currency liabilities, such as the swap with China and the reserves of dollar deposits in the banking system, which exceed international reserves by around US$10 billion. This is something Milei has not discussed in his most recent public appearances. In other words, to dollarize, the central bank would have to sell all its public debt holdings on the market to the private sector, and with the dollars it obtained, pay off the dollar liabilities and then exchange the remainder for the pesos of the monetary base and the leliqs.
To this complex bit of engineering, we have to add two important aspects. One is that the central bank’s largest public debt instrument is a non-transferable letter recorded for accounting purposes at a value of US$65 billion, but which lacks market value because it is non-transferable. Dollarization would thus require the treasury to substitute that letter by issuing new debt that could be negotiated on the markets.
The second point to bear in mind is the value at which public debt could be sold on the market to acquire the dollars needed to dollarize. Here, nobody can do anything but guess. But let’s consider two key facts: debt instruments are currently trading at less than 30 cents on the dollar owed, and the titles of the debt the central bank would have to put on the market to carry out the operation exceed what private holders possess in their portfolios.
Milei argues that, thanks to the credibility of his government, private demand for Argentine debt would grow and the value of the titles would rise. Those of us who teach economics tend to think that when supply increases so much, prices don’t rise, they fall. But supposing for a minute that the market is willing to more than double its holdings of Argentine debt, which today is worth default-level prices, and that the prices stay at current levels, then the exchange rate to dollarize would be around AR$2,000 pesos currently. That’s to say, at today’s values, the blue dollar exchange rate would have to rise by 150% and the official rate, by 450%. At these values, we would undergo something approaching a cycle of hyperinflation during the dollarization transition.
Tsunami of litigation
The complexities don’t end there. We talk of converting the central bank’s pesos to dollars, but what would happen with the peso deposits in the financial system? What would happen with the entire contractual system that today is expressed in pesos? Proponents of dollarization tend to argue that the economy is already dollarized. It’s true that the bulk of assets we use to save are in dollars, and that property transactions are in that currency, but the bulk of the economy’s contractual structure — salaries and rent — is in pesos.
In a few words, an attempt to dollarize would clash with the National Constitution and run the risk of bringing the economy into hyperinflation, a new sovereign debt default, a banking crisis, contractual breakdown, and a tsunami of litigation. In this context, it’s highly likely that the economy would collapse and the social and political situation would deteriorate to a degree we don’t even want to contemplate.
Martín Rapetti is the executive director of the economic analysis center Equilibra.