In today’s Finshots, we explain a radical idea proposed by Argentina’s new incoming President to save the economy.
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4 in 10 people — that’s the number of people living in poverty.
140% — is the current rate of inflation.
90% — how much the Argentine Peso has dropped against the US dollar in the past five years.
Argentina is in economic shambles.
Naturally, the people are livid. They want change. They want a better life. And to get to the promised land, they’ve just booted out the incumbent government and elected a new President. A man named Javier Milei.
And Milei has a radical idea to fix things — He wants to ditch the Argentinian Peso (the domestic currency) and shutter the central bank!
Sounds crazy, right?
But let’s hear him out for a minute.
Argentina’s economic crisis isn’t new. It is what you’d call ‘a country in perpetual crisis’. Inflation has been insanely high for the better part of 50 years now. Heck, Milei says he even gave up his professional career as a footballer in the 1980s because inflation was too rampant. He decided to pour his heart and soul into studying economics instead. He wanted to fix things. And he thinks the root cause of the problem is the central bank itself. See, Argentina doesn’t earn as much money through taxes and exports as it spends on the economy. And whenever the government wanted money to spend — albeit on good things like subsidised healthcare, universities and public transport — the central bank just printed Pesos. It danced to the tunes of the government.
But you know what happens when there’s an oversupply of currency, right? It can lead to inflation or even hyperinflation. And that’s what happened in Argentina.
So, how do you fix this problem?
Well, most people would say that you have to cut back on spending. That you have to try and increase taxes and sell more goods and services to the outside world. But what if the economy has already spiralled out of control? Maybe you need drastic measures.
Ergo, dollarization of the economy!
Milei wants to get rid of the Argentinian peso and use the US dollar as the official currency instead. And since you don’t need a central bank to print and manage your own currency anymore, you can basically shut it down too.
But how will dollarization actually save Argentina, you ask?
Well, let’s look at Zimbabwe which employed a similar tactic in 2009*.
Back then, the country was in the throes of a crisis. The local currency had collapsed and hyperinflation of over 200,000,000% was wiping out savings. The government even had to print a 100 trillion Zimbabwe dollar note to keep up. And as a last resort, the government decided to adopt the US dollar. And within 3 years, inflation had fallen to a steady 3%.
How did that happen?
It’s simple really. Trust!
The thing is people simply distrusted the Zimbabwean dollar. They could hold 1 ZWD today and not know how much it would be worth tomorrow. It could be worth nothing. That meant they had no incentive to save money. They’d go out and spend it. Obviously, the spending behaviour would trigger even more inflation. Retailers might even take products off the shelves just to try and sell them for a higher price later. Again, the shortage of products would create inflation.
It was a vicious cycle.
But then, the US dollar was a shining beacon of light. It was managed by a country that didn’t have the economic scars of Zimbabwe. People could trust it and hold on to the US dollar. They didn’t have to worry about it losing value. That meant they could finally save something and the money in banks swelled by 8 times within a couple of years.
Eventually, when the people hit the brakes on spending, inflation began to fall too.
Also, there was a more important thing. The printing press became quite useless. And the government couldn’t print their own money willy-nilly anymore. They had to be careful with their spending habits. So they decided to only spend what they could earn as cash. Meaning that in order to get dollars into the hands of the people, they’d need to sell more products and services and earn the dollars first. It brought discipline into the chaotic system.
And Argentina is in a similar position today. There’s excessive spending on subsidies. And people already prefer dollars for transactions. So you can see why dollarization seems to be quite an appealing proposition right now.
But it’s not going to be easy for Argentina to do this.
You see, in order to use dollars, you first need to have it in your coffers. You need to have an equivalent amount of dollars to replace the existing pesos. And then you need to keep a liquidity buffer in case something goes wrong in the banking system. Put together, for Argentina, it could be worth $40 billion.
But if you peek into Argentina’s current reserves, you’ll be shocked. The country doesn’t have anything saved up. So it can’t just swap out the currency yet. Now Argentina could borrow the dollars from somewhere else. Say the International Monetary Fund (IMF). But the institution has already bailed Argentina out of trouble 22 times in the past. And Argentina already owes it $44 billion. So the IMF will likely hesitate to finance such a harebrained scheme?
So will Argentina divorce the peso and commit to the US dollar?
We don’t know. Politicians are known to make grand promises that lack substance. It’s all just a charade to get people on their side. Because dollarization also means that you’re dependent on the US for everything. If you think your exports are becoming uncompetitive, you can’t devalue your currency anymore to fix that. There’s stuff like that to keep in mind.
But hey, if Melei does stick to his wild campaign promise, it’ll be the biggest dollarization experiment ever. It’ll be one for the history books and we can’t wait to see how it’ll unfold.
*Zimbabwe ditched the US dollar in 2019. And inflation began to shoot up again.
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