Argentina’s president, Javier Milei, has promised to dollarise the economy and eliminate the central bank to deal with the country’s fiscal crisis and runaway inflation. Bert van Stiphout-Kramer and Petros Milionis look at the theoretical and historical difficulties of transitioning to a rigid monetary regime and recommend careful consideration of both its economic and political implications before any decision is made.
The recent presidential election in Argentina and the unexpected victory of libertarian economist Javier Milei have generated renewed interest in the country’s economic malaise. Argentina has been dealing with soaring inflation rates and an unabating fiscal crisis for several years. Milei has promised to tackle both with a series of radical reforms.
Most prominent among these is a proposal to dismantle the country’s central bank and to replace the Argentinian peso with the US dollar. He claims that doing so will eliminate the ability of the government to monetise fiscal deficits and put an end to triple-digit inflation rates. These claims invoke the experiences of Ecuador, El Salvador and Panama, all of which have already dollarised. Given the much larger size of the Argentinian economy, though, this raises the questions how likely the prospects of an Argentinian dollarisation are and how viable this policy will prove. On these two questions the monetary history of Argentina provides a cautionary tale.
Among all radical economic ideas proposed by Milei during his election campaign, the dollarisation policy generated the most discussion and debate among Argentinians as well as foreign commentators. In a televised debate before the second round of the presidential election, this policy was one of the first lines of attack by his opponent, Sergio Massa, and one of the policy proposals that Milei was most eager to defend. Among libertarian economists the dollarisation policy has been lauded as a bold and effective move to bring down inflation. More left-leaning economists, however, have dismissed it as an ineffective and potentially risky policy choice, which could hurt the more vulnerable socio-economic classes.
Leaving aside questions about the effectiveness of the policy in the long run, some scholars have also raised doubts about the ability of the government to manage the transition process. A key problem would be the lack of dollar reserves by the central bank, which may further fuel inflation before and immediately after a decision to dollarise the economy. Moreover, the introduction of a foreign currency as legal tender implies the end of independent monetary policy, and the closure of the central bank implies the loss of a lender of last resort. This will severely limit the ability of the Argentinian government to weather macroeconomic shocks and is expected to have a negative impact on economic growth.
The policy tradeoffs that come with the choice of monetary regime are commonly viewed in the context of the classic policy trilemma of Robert Mundell, which implies that countries can achieve at most two out of the three following policy objectives: (a) a fixed exchange rate arrangement, (b) free capital mobility, or (c) monetary policy independence. Mundell’s trilemma, however, only considers the economic aspects of a country’s choice of monetary regime. Considering also its political aspects, Dani Rodrik posits the existence of a more general trilemma between the objectives of: (a) economic globalisation, (b) national sovereignty, and (c) a democratic political system, only two out of which can be achieved simultaneously. In the case of Argentina, Rodrik’s trilemma implies that Milei’s radical plan to abolish the Argentinian peso and close the country’s central bank will have to come either at the expense of Argentina’s sovereignty on economic policy or the ability of Argentinians to decide democratically on economic policy priorities.
Although Rodrik motivates his trilemma based on contemporary policy challenges, economic history provides many more examples. A particularly salient one is the failure and eventual collapse of the gold standard during the interwar period (1925-1936). A common explanation for this failure provided by Barry Eichengreen, also relies on the incompatibility between (monetary) globalisation and democratisation, highlighted in Rodrik’s trilemma. As countries became more democratic after World War I, governments found it harder to maintain the economic policies required to uphold the gold standard. This is because, as Eichengreen argues, maintaining convertibility to gold required both fiscal and monetary tightness, which mostly came at the expense of the newly enfranchised working class.
While Eichengreen focused on the turbulent interwar years, as we document in a recent paper, the underlying mechanism operated also before World War I. Looking at the timing of gold standard entry and exit for 30 major economies during the booming years of the first era of globalisation (1860-1914), we find that more democratic countries were, all else equal, less likely to adopt the gold standard and more likely to abandon it.
Our finding also resonates with the experience of Argentina during the pre-WW1 Belle Époque, when it abandoned and re-adopted the gold standard twice. Yet, this experience is much less discussed than the country’s ill-fated experience with dollar convertibility between 1991 and 2002, which was easier to adopt and eventually reverse. In contrast, the adoption of the gold standard requires careful planning, as it severely limits the country’s control over its currency and its ability to regulate its domestic financial markets. Hence, drawing a parallel with the gold standard becomes particularly relevant when exploring the potential implications of dollarisation for larger countries like Argentina, given that all modern-day precedents of dollarisation come from small countries.
This historical parallel, although imperfect, does raise some concerns about the political challenges that Milei’s dollarisation proposal will face if implemented in present-day Argentina. Despite being widely debated during the electoral campaign, it is not clear whether there is a clear preference for dollarisation among Argentinians, who are mostly concerned about bringing inflation under control. Opinion polls indicate a great deal of scepticism for such a radical policy move. These concerns echo past debates regarding the adoption of the gold standard that took place during the late 19th century in Argentina and other countries, which we review in our paper. Moreover, in order for Milei’s government to be able to implement its dollarisation proposal it will have to muster enough support for it among lawmakers in the national congress, where his party currently does not have a majority, and among sub-national governments, which can decide to issue money-like instruments, as they have done in the past. This is another pattern that resonates with the experience of different countries during the gold standard: gold standard adoption was easier for countries where political power was less divided.
Even if Milei succeeds in enacting his dollarisation policy during his presidential term, it is likely that the issue will remain contested particularly if the transition to a dollarised economy is accompanied by economic hardship. Given the current dollar shortage, a dollarisation will probably necessitate a fiscal tightening resulting in a recession and a temporary hike in inflation. One can thus expect that public opinion will, at some point, become less favourable towards dollarisation. The experience of the United States with the gold standard provides an important cautionary tale here: although the 1879 adoption of the gold standard enjoyed wide support at the time, gold convertibility became a major political issue for decades to come. For dollarisation to credibly ‘survive’ such future waves of unpopularity, a return to the peso needs to be not only prohibitively costly economically, but also hard to implement politically by future democratically-elected governments. Even if there is currently a majority favouring dollarisation and the policy appears beneficial in the current macroeconomic environment of high inflation rates, it is important to consider that over time both political sentiments and economic conditions can change.
Following his first months in office, Milei seems to already recognise these issues. His first appointments for the ministry of finance and the central bank suggest that he is turning away from an imminent implementation of his dollarisation proposal. Instead his efforts seem to concentrate on the reduction of the fiscal deficit, which could pave the way to a successful disinflation. While the idea of dollarisation will probably remain on the political agenda in the near future, it is important that both its economic and political implications are carefully considered and discussed before any decision is made to transition to such a rigid monetary regime. Despite the economic challenges that the country is facing, Argentina has managed to establish and maintain over the past forty years a well-functioning democracy, after a very turbulent experience during most of the 20th century. This is an important achievement which needs to be acknowledged by Argentinian political leaders in the ongoing debate about the country’s choice of monetary regime and the constraints resulting from it need to be understood and respected.
- This blog post represents the views of the author(s), not the position of LSE Business Review or the London School of Economics and Political Science.
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