Dollarization is a bitter medicine that should be avoided – 11/27/2023 – Why? Economês in good Portuguese

Javier Milei, the controversial libertarian, was democratically elected president of Argentina. In his campaign platform, he advocated –among other bad things– closing the Central Bank to defeat galloping inflation. Whether it will carry out this and other proposals presented in recent months is difficult to know. Which does not prevent us, obviously, from discussing them at the level of ideas.

First, a clarification. There is a big difference between the so-called liberal way of thinking and Milei’s so-called libertarian thinking. Modern liberal thought is actually less a thought than a method of analysis. There is no established set of truths. Libertarians, on the other hand, are much more doctrinaire, less scientific. “All taxes are theft,” they say. Or “markets are sovereign.” These are ideological statements, not technical ones.

Milei is correct in stating that there is no galloping inflation without a Central Bank that accepts monetizing excessive government spending. The question is: how to solve this problem? Dollarization is an ultra-efficient solution to combat inflation for the simple reason that, from one moment to the next, the Central Bank stops coming to the rescue of an excessively spending government. It’s like amputating a sick limb. The immediate problem disappears.

In episodes of hyperinflation in post-war Europe and Latin America in the 1980s, this was the weapon used to contain the unbridled growth of all prices. And it worked. But it is a solution, in most cases, temporary and with well-known side effects, which should only be used in cases of absolute necessity. Is this the situation in Argentina? For many non-libertarian economists, the answer is “unfortunately, yes.” Since abandoning the fixed exchange rate system at the turn of the century, Argentina has struggled with the problem of inflation, without success. Furthermore: before the implementation of the fixed exchange rate in the early 1990s, Argentina also fought for decades for monetary stability, equally with little success.

When dollarization occurs, in practice what happens is that Argentina’s monetary policy becomes the monetary policy of the United States. But this has a terrible side, as the president of the Central Bank of the United States does not take the state of the Argentine economy into account in his decisions. If the US economy weakens, the Federal Reserve ends up cutting interest rates. – and, if at this moment the Argentine economy is booming, this will harm it, as it needs precisely the opposite remedy. The same goes for when the North American economy is booming and Argentina’s is not. In this scenario, the Central Bank of the United States will raise interest rates, when the best thing for the Argentine economy would be just the opposite. In short, the country loses an instrument to combat economic cycles, which increases the volatility of its economy. But exactly at this moment, an Argentina that can no longer bear living under hyperinflation may consider that every risk to combat it is worth it.

In economic literature, this debate is, not by chance, nicknamed “rules versus discretion”. The rule sticks, which can be a good thing if you can’t avoid hurting yourself. In a diabetic’s home, it’s best not to bring sweets. On the other hand, for those who can control themselves and avoid overeating, it is better to have the option of eating a candy when the need for calories is greater. Flexibility (discretionality) reduces energy fluctuations: eat a lot, avoid candy and burn what is already in your blood; If you’re running a marathon, eat about four to get to the finish line! The problem is not being able to stop eating alfajores, at every meal, with or without a marathon.

Dollarization is a bitter medicine that should be avoided. But not at any cost. Watching the next scenes of the Argentine soap opera.

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