In the context of 104.3% interannual inflation and a persisting increase in the parallel peso-to-dollar exchange rates (the informal “blue” dollar reached AR$420 today), libertarian presidential hopeful Javier Milei has a proposal to solve the country’s economic ordeals — abolish the peso entirely and adopt the US dollar as Argentina’s official currency.
“If you want to end the scam of monetary emission to cover for the treasury and end inflation, given that Argentine politicians are thieves, the only way is to close down the Central Bank and, at the beginning [of my government], dollarize [the economy],” Milei tweeted last week.
Today, Milei emphasized this idea in the Llao Llao Forum.
However, even as “dollarizing the economy” seems to be a popular proposal in a country whose inhabitants have traditionally saved in US dollars outside of the banking system, the consequences could be dire — if it is even possible to apply such a policy.
That is, at least, what consulting firms are saying.
“Asking for calamity”
According to consulting firm 1816, the Central Bank’s net reserves last week were US$1.8 billion, “one of the lowest stocks since the beginning of the century.”
Meanwhile, the country’s monetary base, i.e. all legal currency in circulation or held in reserves, is AR$5.4 trillion. If converted to the blue-chip swap rate, Argentina would need an extra US$11.7 billion to “rescue” its monetary base. However, that doesn’t include liquidity bills — to buy back all of the Central Bank’s liabilities, Argentina would need US$43 billion.
“Another way to put it,” said the report, “is that using the current net reserves, the conversion’s exchange rate would be AR$ 9,944 [per US dollar].”
That is roughly 46 times the current official exchange rate, and 24 times the MEP dollar exchange rate, meaning that Argentine people’s savings would be slashed.
Another consulting firm, Fundar, which calculated the value of the Central Bank’s reserves in March, said that the conversion rate would be at AR$ 7,070 per dollar.
Milei has publicly said that his plan could be based on the book by economists Emilio Ocampo and Nicolás Cachanosky, which also includes the Treasury ‘s bonds as a reserve of value. However, according to 1816, with the bonds at a par value of 25%, Argentina would need an extra US$19.5 billion to “dollarize” at AR$ 400 per dollar, or increase the value of the blue-chip swap rate to 800 pesos— double what it’s worth today. The report raises the questions about whether those bonds effectively would be bought by the market, and whether the market would accept sovereign bonds as collateral.
Fundar echoed those issues in their report, saying that the main problem with this approach is that it assumes that “Argentina would regain access to international markets and that the price of bonds rises considerably” or that the emerging markets bond index (EMBI) would plummet to 1000 basic points. Compiled by JP Morgan, the EMBI is designed to reflect the level of risk associated with investing in or lending to a country. Today, Argentina’s EMBI closed at 2474 basic points.
Other options could include getting an extraordinary loan — something that 1816 heavily questions, given that the country does not have access to the international financial market. In this case, Argentina would need US$43 billion to dollarize with the blue-chip swap dollar at AR$400 and US$21 billion to dollarize with the value at AR$800.
“If we assume that there is not going to be an extraordinary loan, then an ‘orderly’ dollarization is not possible,” the 1816 report said. “There is a concrete chance that the country would dollarize, but it will be with a previous massive currency depreciation and with a pesos default.”
“If the market perceives that Milei has any chances of ruling or influencing a Juntos por el Cambio administration, we should see a run against the peso,” says the report. Two weeks ago, a survey by Poliarquía placed Milei as the candidate with the highest voting intention – 23% while the second one holds a 16%.
“It could even generate a self-fulfilling prophecy: that peso holders fear a dollarization and, when trying to get rid of their holdings, they generate the conditions for a dollarization.”
Emmanuel Álvarez Agis, head of the PXQ consulting firm, agreed.
“If I say ‘there will be no banking system with me’ and I start to rise in the polls, maybe what I want is to generate a bank run so that the economic adjustment will have been made by the market and not by me,” he said during an interview aired on Sunday in El Nueve, referring Milei’s proposals to dollarize the economy and closing down the Central Bank. “But actually, I did it because I am the one calling for that calamity.”
“In that case, I would not have my money in a bank,” he said.
The aftermath of the dollarization would also be grim, according to Fundar. With the loss of monetary policy, the budget’s primary financial result should be balanced. This would imply increasing the tax burden and/or reducing spending.
“This would deepen the fall in income generated by the dollarization itself,” the report read.
The alternative to dollarization is to implement a public policy agenda to strengthen the national currency.