Is the dollar the right answer for the region?
During his campaign, Argentinian president Javier Milei promised to close the country’s central bank and adopt the dollar as the country’s currency. Once elected, he changed his strategy. The natural dollarization approach involves restrictions on the supply of pesos, forcing Argentines to use their reserves in dollars to pay daily expenses.
With the stabilized peso, inflation reached 117% in December 2024, compared to 292% compared to the summit of the year in April, and the use of the dollar should increase, including for daily transactions. “Argentina now has two official currencies, and Milei is counting on people’s savings in dollars to increase the American currency in a local economy,” explains José Leoni, managing director of the company consulting company MoneyMinds Partners.
According to Leoni, dollarization should be a temporary solution, as the main economic problems are not resolved by only controlling currency emissions. Government accounts are in dollars and insufficient savings exist to pay for these debts. “He may not provide enough resources for the economy, and this measure does not solve all the problems,” explains Leoni.
According to Fábio Giambiagi, researcher at the Brazilian Institute of Economy, a unit of the Getulio Vargas Foundation, there is no appropriate way to implement dollarization. “Argentina does not have the reservations to make this transition; And without dollars, there is no dollarization, ”he adds. “Counting personal savings for a government measure is not a replacement for money.”
Eduardo Borensztein and Andrew Berg, the authors of “Full Dollarization: The Pouss and Cons”, published in 2000 by the International Monetary Fund (IMF), examine the potential advantages and the disadvantages of complete dollarization from the point of view of any difficult -fed country. They reveal that dollarization may seem more radical than it is: the use of the US dollar or another major currency is omnipresent to a certain extent in most developing countries, especially in financial contracts.
“The main attraction of complete dollarization is the elimination of the risk of sudden and clear devaluation of the country’s exchange rate,” said IMF editors. “This can allow the country to reduce the risk premium attached to its international loans. Savings in dollars could benefit from a higher level of confidence among international investors, a reduction in interest tariffs on their international loans, a reduction in budget costs and more investments and growth. »»
Latin American experience
It is hardly new. Panama was the first country in Latin America to adopt the US dollar in 1904, shortly after Colombia independence. Almost a century later, Ecuador and Salvador followed suit, with a change of equator in 2000 and El Salvador in 2001. But do they take the appropriate measures to control their economies?
According to Brazilian economist Otaviano Canuto, former vice-president of the World Bank and principal researcher at the Policy Center for the New South, it is logical for some of the smallest economies in Latin America, such as Panama, Salvador and Ecuador, to officially use dollars to keep the economy under control. “Panama’s economy does a lot of dollar transactions on its channel, with container ports and a flagship register,” he says, describing this as a natural path.
Dollarization can make imports cheaper and exports more expensive, depending on the price relationship with other currencies. Thus, the prices of imported goods tend to be more stable, but local goods and services can increase, especially if domestic demand increases.
Since the adoption by Panama in 1904 of the US dollar, the local currency of the country, the Balboa, has been circulating side by side with the dollar. This aimed to maintain economic stability and to open the economy to trade.
Ecuador experienced a significant reduction in inflation and volatility after dollarization in 2000. World Bank data indicates that inflation reached 96.1% in 2000, then decreased to an average of 2.6% from 2004 to 2007. However, the country still faces challenges related to its dependence on sending funds and raw material exports. “The country controls its inflation and counts on foreign currency reserves, so that inflation has been controlled. Oil production has also helped stability, ”says Canuto.
However, there are advantages and disadvantages. The World Bank says that the authors of its 2024 report, Ecuador: Resilient increasing for a better future, “noted that the main structural obstacles to growth include general intervention of the market, lack of competition, limited commercial integration and rigid labor regulations. The country can also face sectoral constraints which prevent it from exploiting opportunities in the sectors where it already has comparative advantages, such as sustainable mining, agriculture and tourism. »»
In El Salvador, employing two currencies – the Colón and the Dollar – have given meaning since a large expatriate population has lived in the United States, and dollars have been circulating regularly in the economy. Inflation was not raised in 2001, around 3.75%, but personal funds represented 15.7% of GDP. After dollarization, this rate increased to 21.8% in 2006 and was 24.1% in 2023, according to the World Bank data. However, the country is still faced with economic challenges, such as low productivity and dependence on funding, which can have an impact on price dynamics.
For the advantages and disadvantages
Emilio Ocampo was an economic adviser from Milei during the 2023 presidential campaign and the designer of a dollarization plan for Argentina. Ocampo is also a finance professor at the University of Cema de Buenos Aires. He explains that the most important factor is the motto that the inhabitants of this particular country prefer to use. “In the case of Argentina, preference is clearly for the US dollar despite not having legal tenders status,” he noted. “It is difficult to force people to accept a currency they do not want to use, like in Salvador [where the government] I tried to impose Bitcoin and it turned against him. »»
He also adds that countries with history of persistent, high and volatile inflation and a population willing to adopt the dollar are main candidates for dollarization.
“If a country adopts the dollar as a legal figure, it should eliminate the central bank. Otherwise, the probability that an unscrupulous politician tries to use it in the future is high, especially in countries addicted to populism, “explains Ocampo. “We have seen how [former Ecuadorian President Rafael Correa] used the central bank to finance part of its excess expenses. The damage he caused was enormous. The equator is always faced with the legacy of Correa’s policies. »»
Ocampo supports the whole region by adopting the dollar. “It would make sense to Latin America to dollarize and integrate more into the American economy. A greater integration into the Americas would create the most powerful economic block in the world. »»
However, the United States should move away from protectionism. “It is unlikely that Brazil will abandon its currency. But if Argentina has adopted the dollar as legal assistance, there would be momentum for other countries in the region, “he suggests.
Dollarization is an economic reform with a strong political component. On the one hand, he limits the government’s maneuvering room by preventing him from printing banknotes to finance budgetary expenses. On the other hand, dollarization makes the government of the country depends on the decisions taken by the United States concerning monetary policy. In fact, by adopting the dollar, countries lose the ability to implement independent monetary policies.
Although inflation can be checked, dollars must effectively manage their tax policies. Inflationist pressures can occur if a healthy budgetary balance is not maintained.