Spoiler alert: if you're looking for a definitive answer, this isn't the place. It's impossible for me to say if this is a good or bad idea. The reality is that ideas are less than 10% of the final result; the execution is always what matters. What you will find here are some tools to help you understand the topic more solidly.

If you live in Argentina, one of the most frequently heard words in the media during 2023 is "dollarization." We probably don't need to review the general points of why Argentina's economy is becoming increasingly difficult to resolve: triple-digit inflation, dollar shortages, fiscal deficit, external debt, lack of credit, inability to rent housing, among many other terms that excite and drive one to Ezeiza in search of an exit.

With the upcoming presidential elections and after seeing the surprising results of the PASO, dollarization seems to be increasingly close to becoming a reality, raising doubts and concerns.

The idea is to cover various items without too much technicality to make it simple to understand, but each item is not correlated with the previous one, so if you're in a hurry and want to get straight to the point, you can do so. Let's get started!

At the end of the post, I leave a glossary with some terms used. If you don't know much about economics, it might be good to start there to better understand the content.

Previous Experience: Menem's 1 to 1

Although it's tough to explain this period briefly, we'll do a quick summary to get into the topic quickly.

The "1 to 1" was an economic plan implemented by Menem in the 1990s and stood out for establishing a fixed parity of 1 Argentine peso to 1 dollar, with the main objective of combating the hyperinflation that the country had experienced and stabilizing the economy.

The similarity between the "1 to 1" and dollarization lies in the fixed parity between the local currency and the US dollar. Both approaches seek to achieve price stability and confidence in the currency.

However, the "1 to 1" plan faced challenges that led to its relatively quick failure (approximately 10 years):

• As parity had to be maintained, the central bank lost tools (monetary policies) normally used to regulate the economy in different changing situations (shocks).

• As prices became dollarized, exporting became less competitive because Argentina became more expensive for the outside world.

• Parallel to the decline in exports due to increased costs, importing became more accessible, damaging the local industry and turning the trade balance negative (importing more than exporting).

• With a more stable economy, access to credit increased, creating a very favorable situation initially but difficult to sustain in the long term.

• To sustain this imbalance with the external market and the level of credit, the only solution left was to incur unsustainable levels of debt, with no path to recovery, leading to the controversial vulture funds.

How Dollarization Would Look

There are different ways to dollarize an economy, some more partial like the 1 to 1, others more absolute, where a country's currency is entirely replaced by dollars.

Based on what's proposed, for anything from going to the local store to buying a car or getting a loan, you would use the same dollars you'd use in the United States, both in cash and with cards and savings accounts.

Why the Dollar

There are many reasons why the dollar might be superior to the Argentine peso, but the main reason for its choice in this discussion is that most of the country has already chosen it as a store of value.

The Argentine population has long adopted the dollar as a reliable currency; real estate prices are in dollars, people save in dollars, and prices, if not in dollars, are usually somewhat tied to the dollar exchange rate. This is called "spontaneous dollarization."

Has Anyone Done It? How Did It Go?

The three most notable countries in Latin America that dollarized are Ecuador, El Salvador, and Panama. In all three cases, it was done as a quick measure to save themselves in a high inflation context, in some cases not as severe as Argentina's current situation.

In all cases, they managed to reduce inflation. Their local currencies continued to circulate alongside the dollar but to a much lesser extent, and today they practically don't exist. At first glance, this seems very tempting, but not everything is rosy.

Despite being able to control inflation, they face significant challenges today, the three main ones being:

1. Price Distortion: It made their economies more expensive for their people, making many things inaccessible for the majority.

2. Industry Destruction: The three countries became almost entirely importers due to loss of competitiveness, not only becoming more dependent but also increasing unemployment and severely limiting their growth capacity.

3. Susceptibility to Shocks: In the face of any shock they might experience, such as COVID, the inability to adjust the exchange rate limits the ability to cushion the impact.

Why Eliminate the Central Bank?

The main tasks of each country's Central Bank are to supervise, regulate, and control the monetary and financial policy to maintain economic and financial stability, promote sustainable growth, and keep inflation under control.

The problem arises when it is mismanaged, and those who control it abuse their functions, leading to economic situations like Argentina's.

In the case of dollarization, the Central Bank's functions become very limited since it loses control of many primary functions it previously had, so the most natural solution seems to be eliminating it completely.

However, this doesn't necessarily have to be the case. There could be a redefinition of its role, which could be favorable for the country, especially in Argentina's case, which has great productive potential. No power became a power without a Central Bank and with another country's currency, which means these measures could greatly limit the country.

If eliminated, it would somehow depend on the entity issuing the adopted currency, so the Federal Reserve (the Central Bank of the United States) could be considered our new agency responsible for controlling currency issuance, money supply, interest rates, monetary policy, inflation control, and financial stability.

Naturally, the problem with this is that Argentina probably wouldn't be a priority for the Federal Reserve, making it susceptible to decisions based on an economy that isn't ours.

What About the Currency Controls?

Currency controls limit free access to the currency market in Argentina today. They are usually placed when a country doesn't have a solid supply of foreign currency to allow people to operate freely.

In the case of dollarization, lifting the controls is one of the first measures that would need to be taken. Today, Argentina's economy is tied up with so many wires and has so many exchange rates that it's hard to know the dollar's true value, so lifting the controls is necessary for the dollar to find its real value, and then pesos can be exchanged for dollars.

This creates uncertainty because, when ripping off the band-aid, we don't know if we're removing a patch from a glass of water or demolishing a dam. The dollar could reach much higher values by releasing the control, causing a devaluation, perhaps anticipated but quite abrupt and higher than stipulated.

Goodbye to Inflation?

The easy answer we all want to hear is yes, but it's not quite like that. At first glance, what is 100% certain is that the dollar is not exempt from inflation; in fact, it is currently recovering after nearing 10% a year ago.

It seems small, but the normal rate for the United States has always been between 2% and 3%, which, compared to the Argentine peso, sounds like science fiction.

However, there are other factors separate from the North American economy that could affect prices in a dollarized Argentina:

• Internal Costs: Local wages and inputs could increase, which could translate into the prices of goods and services.

• Internal Demand: If internal demand exceeds the supply of goods and services, there could be inflationary pressures, which could occur if the population has greater purchasing power.

• External Effects: Changes in international prices of basic products or imported inputs could affect internal prices, even in a dollarized economy.

The reality is that in terms of inflation or price increases, a dollarized economy tends to be very stable compared to Argentina's current situation. However, it doesn't guarantee that goods and services will maintain their prices forever.

Inflation Tricks

Most people take advantage of the current economic situation by using low or zero-interest installment payments, financial loopholes, imports at the official dollar rate, and other economic tricks to access goods at lower prices or obtain an economic difference.

If the economy stabilizes, installment payments won't necessarily disappear, but the benefits of devaluation or different exchange rates probably will.

Salaries and Prices

This is a delicate topic that generates a lot of excitement and is very difficult to estimate. In economics, there's a concept called "ceteris paribus," which means "all other things being equal."

Let's propose an example to see this a bit better; if we do ceteris paribus in terms of peso to dollar exchange, say the exchange rate is $730 per USD 1, if a person earns $73,000, they would immediately earn USD 100 per month, and if a pack of gum costs $730, it would cost USD 1. Quite linear.

However, thinking this way is only possible in theory; there are thousands of factors in the equation that determine what would happen and must be considered for an estimate.

Today we live in a very fragmented economy; for example, a coffee that costs $1,000 would hardly be worth USD 1.37 due to price distortion; many times, inputs are imported at the official dollar rate, so before a level adjustment of the exchange rate, input costs could double.

The reality is that the numbers matter little; in the United States, a minimum wage can be up to 20 times higher than in Argentina, but the cost of living is also that high. Therefore, what we should really be interested in is: what will happen to purchasing power? Will we be able to access more, the same, or less?

In the short term, the best to hope for is that purchasing power remains stable and doesn't happen as in Ecuador and El Salvador, where the population lost access to many things they previously could access.

What is certain and important to understand is that if one believes that earning the equivalent of USD 500 will suddenly become USD 5,000 just by dollarizing, there's a high probability that won't happen.

Increasing purchasing power depends on years of economic stability, growth, both general and individual, and policies that accompany such growth.

What About Those Who Already Earn in Dollars?

Today, there are two main regimes in which people earn dollars from Argentina, formal (legal) and informal (illegal).

The former earn dollars but their liquidations are in pesos at the official exchange rate, so dollarization would probably be favorable because, without changing their salary, their purchasing power would practically double at the current exchange rates.

For the latter, purchasing power would be affected only by price fluctuations, but it shouldn't change substantially in the medium term. In summary, free exchange and stability could create incentives to formalize their economy with fewer disadvantages than currently.

Taxes and Withholdings

This is a topic that doesn't necessarily have to do with dollarization per se. Even in the United States, the tax burden is quite high.

However, such initiatives tend to be quite liberal, which could be accompanied by policies that reduce the tax burden in the country. So, although not directly related, it's possible that in line with liberal thinking, taxes could decrease.

Some effects of this could be price reductions, production incentives, increased purchasing power, reduced unemployment, and incentives for exports and imports.

An important effect is the fall in state revenue, forcing the state to downsize or seek financing by other means to sustain itself.

Credit and Mortgages

Today, Argentina has one of the lowest credit rates in proportion to GDP per capita in the region. While countries like Chile or Brazil have rates between 70% and 80%, Argentina is at 6%. (This means banks lend a lot in some countries, and in Argentina, almost nothing.)

This is something we see every day; aspiring to buy a home with credit or taking a loan to start a business seems like something out of a movie.

This mainly happens because creating long-term contracts based on an economy as volatile as Argentina's and a population with little payment capacity is a highly risky operation for banks to prefer allocating their capital to that versus buying state debt with favorable short-term returns.

In a dollarized economy, not only would the state reduce its capacity to issue debt, but also stability could incentivize banks to start distributing more credit to the population, facilitating housing and business projects, improving quality of life, reducing unemployment, and favoring economic growth.

Bank Run Risks

A bank run is always a latent risk when such significant changes are made abruptly. A bank run, or bank panic, consists of a large portion of the population deciding to withdraw all their money from banks for various reasons.

Part of bank operations involves placing part of the money they manage in different investments or loans, keeping only a certain amount for regular customer operations, called bank reserves.

This means that if all a bank's customers wanted to withdraw all their deposits simultaneously, the bank would be unable to deliver all the money due to lack of liquidity. This can result in various outcomes, the worst being the bank's bankruptcy due to insolvency.

If the removal of currency controls and free dollar fluctuation is announced, one could assume it would generate an abrupt devaluation, so the most reasonable decision to prevent one's money from losing value would be to withdraw it before it happens and buy dollars before the money loses its value.

If the entire country were informed and made this decision, we could face a significant bank run. However, a large portion of deposits belongs to companies, and for most of them, acquiring dollars is impossible, both officially and in the informal market (blue dollar). This would greatly soften the impact of policy changes and thus reduce the likelihood of a bank run.

Conclusion and Alternatives

If you've made it this far, you probably realize that the effect is quite difficult to predict. Dollarization can't be seen as an isolated process from the rest of the economy, and factors like external trade control, timing, policy smoothness, taxes, people's behavior, among many others, form a large part of the final result.

If the goal is to reduce inflation in the short term, dollarization might be one of the quickest shortcuts to achieve it. But as seen before, Argentina being a country with great productive potential, eliminating its currency could limit the country in the long term, as happened with some countries that went through this process.

The alternative to all this would be not to dollarize (ha). Through structural reforms, stabilization policies, and measures to promote national investment and production, with fiscal deficit reduction at the center of the storm, the economy could stabilize, and the local currency could be strengthened.

Unfortunately, this is not a quick path. The good news is that there will always be time to dollarize, while undoing that change and rebuilding a Central Bank and currency can be very challenging.

The answer to all this is a big unknown that I don't think anyone knows for sure. I hope this blog has provided some sufficiently objective and simple ideas to help understand a bit better and facilitate forming a more robust opinion on whether dollarization is the right choice for Argentina. Thank you!

Glossary

Although there are words we hear repeatedly, we often don't fully understand what they mean. I leave this mini glossary as an opportunity to better understand some economic concepts that are simpler than they seem.

• Inflation: General price increase in the economy.

• Monetary Policy: Control of money and interest rates by the central government.

• Vulture Funds: Investors who buy debt at low prices to later demand full payment.

• Trade Balance: Difference between a country's exports and imports.

• Fiscal Deficit: Government spending greater than revenue.

• External Debt: Money a country owes to other countries or organizations.

• Ezeiza as an Exit: Reference to leaving the country, often in search of better opportunities.

• Central Bank (BCRA): Government institution that controls currency and monetary policy.

• Minimum Wage: Legal minimum payment for work.

• Credit and Mortgages: Loans to buy goods or properties.

• Bank Run: Many people withdrawing money from the bank at the same time.

• Quality of Life: Level of well-being and comfort in daily life.

• Income Distribution: How income is divided in a society.

• Informal Economy: Unregulated or undeclared economic activities.

• Currency Controls: Restrictions on foreign currency exchange.

• Economic Shocks: Unexpected events that affect the economy.

• Exports: Goods sold to other countries.

• Imports: Goods bought from other countries.

• Bubble: Excessive and temporary increase in an asset's value.

• Price Distortion: Changes in prices that don't reflect real value.

• Tax Burden: Amount of taxes paid.

• Withholdings: Taxes on exports.

• GDP per Capita: Average value of production per person in a country.