All the talk and scribbling about the infeasibility of dollarization in Argentina is simply wrong.
Carlos Menem was elected president of Argentina in May 1989. In the 45 preceding years, Argentina had witnessed unstable, slow growth, and rampant inflation. As if to usher in Menem, a bout of hyperinflation broke out the month he was elected president. It peaked in July 1989, when the monthly inflation rate reached 197 percent. If that wasn’t bad enough, the economy, according to Domingo Cavallo, Menem’s minister of economy, “was so complicated that not even specialists could understand what went on.” Anomie prevailed.
President Menem set out to clean the stables, but early on, the going was slow. In late 1989, one of us (Hanke) met Menem for the first time. During that meeting, I advised Menem that until he killed the hyperinflation and stabilized the economy, he would not be viewed as credible and would lack the public’s trust. Without that credibility and trust, he would not be able to move forward with his economic-modernization plans.
At President Menem’s suggestion, I co-authored a book, ¿Banco central o caja de conversión?, with Kurt Schuler, while he was working with me as a postdoctoral fellow at Johns Hopkins. We laid out a blueprint for an orthodox currency board. It would have replaced Argentina’s central bank (BCRA). And unlike the BCRA, it would have had no capacity to engage in monetary policy; it would only have had an exchange-rate policy: the peso–U.S. dollar rate would have been fixed, and the rate would have been credible because the peso would have been fully backed by U.S. dollar reserves. A draft of our book circulated in Buenos Aires in 1990 and was published by the Fundación República in early 1991.
To stop Argentina’s triple-digit inflation, the Menem administration decided not to introduce a currency board, but rather introduced a convertibility system, which pegged the peso to the U.S. dollar at a 1:1 rate. It did so on April 1, 1991. While convertibility stopped inflation in its tracks and laid the foundation for an economic boom, it was administered by the BCRA, which had the capacity to engage in discretionary monetary policies. For me, this capacity was convertibility’s Achilles’ heel. The BCRA’s discretionary powers were the equivalent of setting a bottle of whiskey next to a recovering alcoholic. Shortly after convertibility’s introduction, I penned an op-ed in the the Wall Street Journal, “Argentina Should Abolish its Central Bank,” in which I argued that convertibility was not a currency board and that, unless the BCRA’s power to engage in discretion was removed, convertibility would eventually collapse.
Sure enough, in 1998, convertibility started to show signs of trouble. Menem again called me in for advice and requested a draft dollarization law. Kurt Schuler and I published “A Dollarization Blueprint for Argentina” on February 1, 1999. Unfortunately, dollarization never became the law of the land. As they say, the rest is history. Indeed, Argentina has been embroiled in one currency crisis after another ever since convertibility was abandoned amid political and economic chaos in 2002.
This brings us to Argentina’s newly elected president, Javier Milei. The scope and scale of the economic problems he faces are broadly the same as those that Carlos Menem faced 35 years ago. Although it’s not hyperinflation, Argentines have suffered from triple-digit inflation since February of last year.
President Milei campaigned on the promise to kill inflation by mothballing the BCRA and peso and replacing them with the U.S. dollar. It seemed as though he had learned one big lesson from Menem, namely, to become credible and gain the public’s trust, inflation must be crushed.
But once in office, Milei shelved dollarization, promising that it would arrive at some future, unspecified date. Apparently, Milei was spooked by a chorus of experts, including his own, who claimed that dollarization was not feasible without the receipt of a large loan because Argentina didn’t have enough foreign-exchange reserves to dollarize.
This is unfortunate and could doom Milei. As it turns out, the chorus of experts is singing from a defective songbook. To dollarize, the only thing that must be physically converted into U.S. dollars is Argentina’s outstanding stock of peso notes and coins. To make that conversion, gross foreign-exchange reserves in dollars must exceed the value of the outstanding stock of peso notes and coins at the exchange rate decided on at the time of dollarization. All other peso assets and liabilities are simply nominal claims or IOUs that can be expressed or redenominated at any time in any unit of account or currency. They are not physical units that must remain intact until their maturity date.
As of December 31 and at Argentina’s official exchange rate, the BCRA reported “International Reserves” of AR$ 18,654 billion pesos (US$ 23.1 billion), significantly more than the AR$ 7,435 billion (US$ 9.2 billion) in “Banknotes and Coins in Circulation.” Therefore, the stock of liquid unencumbered gross reserves is more than adequate to successfully convert Argentina’s stock of peso notes and coins into U.S. dollars. The experts clearly have things wrong.
Just how could so many experts be so wrong? First, they have failed to realize that, with the exception of peso notes and coins outstanding, a stroke of the pen is all that is required to redenominate peso assets and liabilities into greenbacks. In consequence, they have exaggerated the amount of foreign exchange that would be required to dollarize Argentina.
If that’s not bad enough, most experts believe that dollarization can only occur when a country’s net international foreign-exchange reserves are adequate. But, when determining the feasibility of dollarization, the value of net international foreign-exchange reserves turns out to be irrelevant. It is gross liquid foreign-exchange reserves that are relevant, not net reserves.
Contrary to the deficiency of the foreign-exchange arguments that have spooked Milei, our analysis is based on sound economics and first-hand experience. Indeed, one of us (Zalles) served as an advisor to Ecuador’s president Gustavo Noboa when it dollarized. And both of us served as advisors to Ecuador’s minister of economy and finance, Carlos Julio Emanuel, who was responsible for the final implementation of dollarization.
At the time Ecuador dollarized, its gross unencumbered reserves were US$ 872 million. Those were enough to cover the stock of outstanding sucre notes and coins of US$ 578 million. Interestingly, at the time of dollarization, Ecuador’s net international foreign-exchange position was negative. Indeed, Ecuador’s net reserves were a negative US$ 619 million.
All the talk and scribbling about the infeasibility of dollarization in Argentina because of a lack of international foreign-exchange reserves is simply wrong. Official dollarization in Argentina is both desirable and feasible.
Until he pulled the trigger and introduced convertibility to kill inflation, President Menem was going nowhere. Once inflation was crushed, Menem’s modernization reforms started moving. Menem’s message for Milei is clear: To succeed, a currency reform to kill inflation must come first, not last.
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, Carlos Julio Emanuel, when Ecuador was dollarized in 2001. He advised Argentine president Carlos Menem from 1989 to 1999.
Francisco Zalles is an adjunct scholar at the Ecuadorian Institute for Political Economy. He served as an adviser to Ecuador’s president, Gustavo Noboa, and subsequently various ministers of economy and finance, including Carlos Julio Emanuel, when Ecuador was dollarized in 2001.