Dollarization is not the way to go — even the Austrian School says so

The proposal of pure and simple dollarization is illogical unless the United States starts by eliminating its own central bank

By Prof. Fernando Ruiz Heiland, Ecole Royale Militaire (Belgium)

Javier Milei seems to be orienting the Argentine economy towards imminent dollarization. However, even economists of the Austrian School the president abides by are questioning its long-term relevance, as illustrated by Kristoffer Hansen’s recent analysis. I have previously argued that dollarization may not be the most suitable strategy for Argentina. Now, I intend to expand on why this measure may be inadequate — even from an Austrian School perspective. 

The main challenge for most economists who criticize Javier Milei lies in an incorrect understanding of his proposals and definitions. Economists, both locally and internationally, usually rely on neoclassical or Keynesian paradigms, which dominate university economics education. 

Therefore, it is not surprising to hear critics warning, with a certain degree of justification, that Milei’s proposals could lead us into recession, or arguing that he lacks an effective program to fight inflation. These statements are valid within neoclassical or Keynesian theoretical frameworks. But they become questionable when examined from the perspective of the Austrian school of economics. While this vision is considered marginal and minor in the field of economics, it does offer an alternative interpretation of policies and their potential economic impacts.

A fundamental distinction lies in the Austrian interpretation of the economic cycle, an interpretation developed at the beginning of the 20th century by economists such as Ludwig von Mises and Friedrich Hayek. At the time, the prevailing context supported the use of the gold standard as a monetary base, a very different structure from today. Despite the changes, this is still argued by a group of economists, mostly in the United States, where its principles still find fertile ground for their justification.

The Austrian school’s notion of the economic cycle maintains that the interest rate is key to coordinating consumption and production over time. In this context, the loan market is made up of consumers who choose to save, thus postponing their consumption, along with producers who wish to make investments in technology to increase future production. This dynamic in the market results in a natural rate of interest. Put simply, this interest rate compensates savers for their willingness to wait, and is equal to the increase in future production that results from new investments.

From the Austrian point of view, the interest rate is fundamental to economic coordination: when consumers choose to save more — that is, delay more consumption — the interest rate decreases. This reduction lowers the financing cost of investments, which in turn stimulates an increase in investment and, therefore, in available capital (for example, companies can purchase more machinery). This increase in investment helps the production of a greater quantity of goods that will be available for future consumption. Thus, consumers who chose to save in the present have greater resources to acquire these goods in the future, effectively closing the cycle of intertemporal coordination.

In short, this intertemporal coordination mechanism is one of the fundamental pillars of Austrian economics, which is rarely addressed in traditional university programs. Based on this principle, Austrian economists argue that any central bank intervention that artificially alters the interest rate causes a harmful inconsistency in the market. This manipulation results in a misalignment between consumption preferences and production decisions.

The central bank lowering the interest rate motivates savers to reduce their savings and increase their immediate consumption, since the incentive to postpone said consumption is lower. Simultaneously, this reduction in the interest rate motivates producers to increase their investments, in order to obtain greater future production. This situation gives rise to what is known as an intertemporal inconsistency, which Austrian economists point out critically in relation to central bank interventions. On the one hand, we have producers who are getting ready to offer more goods in the future, while, on the other, consumers seduced by the central bank’s lower interest rate aim to increase their consumption today, not in the future.

This intertemporal inconsistency triggers competition between consumers and producers for resources, as both seek to simultaneously increase their consumption and investment. However, credit expansion driven by the central bank’s monetary policy generally favors producers, who are incentivized to increase their investments. This phenomenon damages consumers, who cannot increase their consumption to their desired extent, which results in forced savings (and an increase in prices).

Based on that line of thought, Javier Milei thinks the central bank’s actions do not favor consumers. If we accept this line of thinking for a moment and consider a situation where Milei dollarizes the economy and suppresses the central bank, we find ourselves with a scenario where the interest rate in the loan market should be determined naturally. 

In this context, without central bank intervention, interest rates would be a more faithful reflection of the real dynamics between savings and investment, as they emanate from the free choices of consumers and producers. Theoretically, this would result in a more effective coordination between present savings and future production, aligning economic decisions more precisely with society’s real preferences.

This, however, is impossible. And there is a very simple reason. Decisions made by the American Federal Reserve (Fed, the US Central Bank) would still impact the local interest rate. Since the Fed is not governed by the principles of the Austrian school of economics, its monetary policy would have a direct impact on the interest rate in a dollarized economy, thus distorting the proposed “natural” rate setting mechanism. 

Even if the government managed to isolate its local market from the direct influence of the Fed, US monetary policies would still benefit US companies. This would lead to a continued loss of competitiveness for local businesses. The inevitable consequence would be a disincentive for local investment and, potentially, capital flight to other markets. Another solution would be to completely close the economy to international competition to protect it, but this contradicts any liberal economic principle.

Even from the Austrian perspective, the proposal of pure and simple dollarization is illogical unless the United States starts by eliminating its own central bank. Aware of these challenges, Javier Milei frequently advocates the alternative of monetary competition, a more accepted proposal that echoes the Austrian libertarian vision. This will certainly be an interesting topic to watch.

Beyond all this, the current political landscape shows considerable challenges for Milei, particularly as the so-called “caste” begins to notice that they are the ones who must endure the spending cuts, and the government’s political leadership moves like a bull in a china shop. In this scenario, a segment of the population demands dollars, since they view dollarization as a straight, simple response to the inflation problem. While it’s not the best alternative from a comprehensive economic perspective, certain people in the country and abroad seem to be pushing the government towards taking this measure in the coming weeks.

Choosing immediate solutions instead of long-term strategies that could be more advantageous poses a complicated dilemma. Whether the government will maintain a certain level of lucidity and critical judgment in the face of the political crisis it currently faces, remains to be seen.

Translated by Agustín Mango. A version of this piece was originally published in La Voz.


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