Official dollarization would ratify the choices made by most Argentines in their own affairs.
Javier Milei’s victory in Argentina’s presidential election was a resounding endorsement of dollarization for Argentina. Official dollarization would ratify the choices made by most Argentines in their own affairs (especially when it comes to larger transactions, whether buying a house or a household appliance) and end two decades of currency depreciation, inflation, and high interest rates. It would also make Argentina’s central bank, the Banco Central de la República Argentina (BCRA), redundant.
Yet the opinion persists among many economists that Argentina lacks the funds to dollarize at prevailing exchange rates (about 350:1 officially). Without more dollars or a massive devaluation of the peso, they say, dollarization is impossible. We disagree: Argentina has all the dollars it needs to dollarize officially and eliminate the BCRA.
The balance sheet of the BCRA consists of foreign reserves and domestic credit assets, while its liabilities include the monetary base, government deposit accounts, and several kinds of short-term debt securities. The BCRA’s liabilities totaled 63,800 billion pesos as of November 23.
Most economists believe that dollarization would require the redemption of all central-bank liabilities with the BCRA’s foreign reserves. With $21.551 billion (7,694 billion pesos) in gross foreign reserves as of November 23, only 13 percent of the bank’s liabilities are covered at the official exchange rate of roughly 357 to the dollar. Redemption of all liabilities in dollars would require a peso exchange rate of 2,960:1. This is the conventional wisdom about dollarization.
But most economists overlook the fact that dollarization, for the most part, is nothing more than a change in a country’s unit of account, accomplished at the stroke of a pen as obligations are redenominated. Given a conversion rate (we discuss how that might be established below), most of the BCRA’s liabilities can be transformed into dollar liabilities without settlement in foreign currency. The only BCRA liability that must be redeemed in dollars is the 6,000 billion pesos of cash in circulation, which are more than adequately covered by the BCRA’s gross foreign reserves at the current official exchange rate.
The BCRA’s assets and liabilities, now denominated in dollars, may be consolidated with the government’s finances. Government deposit accounts can shift to commercial banks. Responsibility for monetary policy effectively passes to the U.S. Federal Reserve. Lender-of-last-resort operations can be replicated in the international dollar-based money market. Clearing systems operated by the BCRA, where bank reserve balances redenominated in dollars will continue to settle transactions in bank money, can continue operating independently. Dollar settlements with foreign banks can be achieved via CLS Bank or correspondent banking relationships, as they are everywhere else. Regulation of the banking system may be undertaken by a newly chartered entity, possibly drawing on legacy BCRA staff and systems.
What is the right exchange rate for retiring the peso? The right number probably lies between the official rate and the black-market rate of roughly 1000:1. The World Bank’s purchasing power parity (PPP) conversion factors have long suggested an equilibrium exchange rate of roughly half the official rate. One-year lending rates of some 100 percent suggest a similar rate when calculated on an interest-rate-parity basis.
Rather than set a conversion rate in advance, we propose that Argentina follow the procedure used by one of us (Hanke) in Bulgaria to fix the exchange rate used in the establishment of its currency board in 1997. On the same date on which dollarization is announced, Argentina’s peso monetary base would be frozen. Then, the peso–dollar exchange rate would be allowed to float freely for the next 30 days. At the end of that period, the market rates that have been realized would be observed and the appropriate exchange rate would be determined, keeping in mind the bench calculations based on the World Bank’s PPP conversion factors, as well as the exchange rate determined on an interest-rate parity basis.
Though we have shown dollarization is possible without further ado, there will remain those who fret about the optimality of Federal Reserve policy for Argentina’s business cycle and trade positions. Such objections assume that the alternative to dollarization is a highly competent, precisely operated central banking regime. The conditions for the latter have eluded Argentina for most of its history. As a succession of governments has found the temptation to monetize fiscal deficits irresistible, monetary policy has become the main source of shocks to the Argentine economy. Relative stability has prevailed only under the fixed exchange-rate regime imposed by Argentina’s Convertibility system (1991–2001). It’s time to mothball the BCRA and the peso, put them in museums, and replace them with the Federal Reserve’s monetary policy and the U.S. dollar. It’s not only desirable, but feasible.
Steve H. Hanke is a professor of applied economics at the Johns Hopkins University in Baltimore, Md., and a senior fellow at the Independent Institute in Oakland, Calif. As President Milo Dukanovic’s chief adviser, Hanke designed and implemented Montenegro’s “dollarization” in 1999 and was an adviser to Ecuador’s minister of economy and finance when it was dollarized in 2001. He advised Argentine president Carlos Menem from 1989 to 1999.
Matt Sekerke is a fellow at the Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise.