October 28, 2023


The Dollarization Threat

Javier Milei and Argentina’s pivotal election

The results of Argentina’s first round elections on October 22 again defied expectations. Conservative former security minister and election favorite Patricia Bullrich came in third place, knocking her out of the running for the presidency, which will be decided on November 19 at a runoff election between the current Peronist finance minister Sergio Massa and the far-right economist Javier Milei. Having won 36.6 percent of the vote—compared to Milei’s 29.9 percent—Massa remains the frontrunner, but it remains unclear whether Bullrich’s supporters will side with the Peronist figurehead of the crisis-ridden economy or the far-right outsider next month. 

To some extent, questions of democracy are at stake; Milei has said explicitly that Argentina’s problems can be traced back to 1916 when a new law allowing universal male suffrage led to the first popular government in the country’s history. Milei’s most publicized economic proposals—dollarization, the abolition of the central bank, and the end of trade with China—would deliver painful repercussions. But Argentina’s difficulties date far back, with the spectacular crisis of 2001-2 only as the most recent case. The question is whether the country can cope with another such crisis, after suffering from political instability and economic stagnation for more than fifty years.

The backdrop of the current political crisis is Argentina’s dire economic situation—the country is on the verge of another external crisis. The central bank has run out of foreign reserves, and the only reason a default will be avoided, at least this year, is that there are no significant outstanding outlays other than to the International Monetary Fund (IMF). The lack of dollars means that the economy cannot import essential goods. A recession is very likely this year, compounding almost a decade of stagnation. The inability to manage the exchange rate—which has tumbled against the dollar—means that the price of imported goods continues increase. This in turn stimulates inflation, which is now at a rate of more than 120 percent. The scarcity of dollars has detrimental effects, too, even if a full-fledged hyperinflation crisis can be avoided before the end of the year, when a new government will be sworn in. 

The fears now are of a complete collapse of the political institutions and the end of the democratic experiment that started forty years ago with the fall of the last dictatorship in 1983. A self-described “anticasta”—an outsider from what he sees as the nation’s “political caste”—Milei has crowned himself the leader of a rising authoritarian right. He promises to break the pattern of stagnation and inflation that has afflicted both the center-left and -right over the past two decades, but the proposed solutions threaten even greater turmoil.

State of crisis

It is important to note that the Argentine crisis has had a long gestation; responsibility for the problems lies beyond the current government of Alberto Fernández. The Argentine economy recovered swiftly after the 2002 default. Néstor Kirchner was elected in 2003, at the beginning of a period that was globally favorable to developing countries, with low interest rates in the United States following the dot-com bubble and high growth rates in China, which had just entered the World Trade Organization (WTO), leading to higher prices of commodities, including soybeans, Argentina’s main export. Kirchner renegotiated the external debt with foreign creditors and reduced debt in foreign currency by half while also increasing exports, helping to service the foreign debt.1

By 2010, when Kirchner passed away, Argentina had paid back its debt with the IMF. Economic prospects seemed relatively bright. Kirchner’s wife, Cristina Fernández de Kirchner, had been elected in 2007, and was easily reelected in 2011. The government had imposed higher taxes on exports, and though this had angered landowners and soybean producers, nothing indicated that a crisis was brewing, even in the context of the housing-bubble collapse in the US and the European debt crisis of 2010. It was at this time, however, that the external problems began to intensify; while many countries in the periphery accumulated significant amounts of dollars, the Argentine central bank maintained relatively low interest rates and failed to beef up its international reserves.

The path taken was to maintain relatively low interest rates, seen by many within Kirchnerist progressive circles as essential for credit expansion and growth, while at the same time promoting the depreciation of the nominal exchange rate to stimulate exports. In reality, however, low interest rates drained current-account surpluses, which in turn meant reduced government spending in an effort to control imports, which ultimately cramped growth. At the same time, the depreciation of the currency and the resulting higher prices on imported goods, combined with the wage increases demanded by trade unions, led to higher inflation.2 With growth rates low and inflation surging, Mauricio Macri came to power in 2015, renewing the neoliberal project after twelve years of Peronist government.

Macri promised to stabilize the economy. He appointed Federico Sturzenegger—an economist who had worked with Domingo Cavallo before the 2002 crisis—as president of the central bank and promoted the bank’s independence as an inflation-fighting institution that could bring down prices. Nonetheless, inflation accelerated and hit close to 50 percent by the end of his tenure in 2019. Elsewhere, Macri removed controls on the purchase of foreign currency, which had been introduced in 2011. The government paid the debt with the so-called Vulture Funds, which allowed it to borrow significant amounts of dollars abroad. However, domestic interest rates remained low, for the most part, and the central bank did not accumulate foreign reserves. By 2018, Argentina had more than doubled its foreign debt in dollars, and the central bank lacked the reserves required to face the short term needs of the country, forcing Macri to go to the IMF to obtain the largest loan in the history of the institution.

Argentina’s particularly low interest rate means that the country’s main economic actors prefer to hold dollars rather than pesos.3 While the Kirchners wanted low interest rates to stimulate the economy, the Macri administration initially maintained low rates to allow some inflation acceleration to reduce real wages.4 In other words, the inability to accumulate dollars, for different reasons, has plagued both left and right of center governments, and has fueled the political pendulum in which Peronists and anti-Peronists alternate in power. 

The run-off

For the past four years, Kirchnerists in coalition with more centrist groups within Peronism have held power amid this economic instability. Given widespread discontent in the run up to the election, many expected that a center-right candidate, probably from the Macri coalition, would win. The surprise has been, first, Milei’s victory in the primaries, and then his passing to the second round last Sunday.

Milei is often described as a representative of the region’s new authoritarian right, comparable to Jair Bolsonaro in Brazil or José Antonio Kast in Chile. It is clear that Milei’s primaries’ victory was the product of both popular anger and exhaustion with the inability of the traditional political parties to deal with the economic crisis. However, it is important to note that Milei is not a complete outsider, and neither is he a completely new phenomenon in Argentine politics.

While Milei has almost no political experience, he has links to the most prominent economic corporations in the country and until recently worked for one of the main media groups. These connections opened many doors, providing him the media exposure that helped catapult his campaign. The team that he announced, should he be successful in the second-round election on November 19, includes experienced figures in previous neoliberal Argentinian projects, from the National Reorganization Process to the Menem and Macri administrations. In that sense, a Milei government would constitute the fourth coming of the neoliberal order in Argentina. The policies would likely be very similar to neoliberal predecessors, pushing austerity, liberalization, deregulation, and privatization—a difficult situation, given the destructive power of these policies, but hardly something new.

Milei’s biggest threat has been his pledge to formally dollarize the Argentine economy. The consequences could be dire. There is overwhelming evidence that dollarization leads to slower growth, largely because it reduces the space for fiscal policy. In a dollarized economy, the interest rate is set by a foreign authority unconcerned with the domestic economy and its needs. Very often, developing countries are forced to drastically reduce spending, more often than not cutting social benefits, in order to reduce income and the imports associated with it. Low growth becomes instrumental in dealing with the external constraints. The case of Greece, which formally adopted the euro in 2002, is very illustrative. Greek incomes grew significantly after the entry in the euro, as capital inflows allowed an expansion that led to higher wages domestically. However, the European debt crisis led GDP to collapse; a decade later, it remains at 23 percent below its peak. The fall in GDP, high levels of unemployment, and lower real wages are instrumental in promoting external adjustment.

It is true that dollarization tends to lead to lower inflation, but there are less drastic alternatives. An exchange rate anchor is often used to stabilize the economy and could be achieved if the central bank accumulates enough reserves while still propping up the peso, making it profitable for people to use the domestic currency. This option could be available to Massa, but the uncertainty hinges on whether the fear of a Milei presidency, with its grim prescriptions, outweighs the popular anger against the “political caste.”

  1.  See De Lucchi, J. M. and Vernengo, M. (2023), “The new foreign debt trap and its long run consequences: the persistence of Monetarism as a social doctrine in Argentina,” in F. Ferrari Filho and L. F. de Paula (eds.), Central Banks and Monetary Regimes in Emerging Countries: Theoretical and Empirical Analysis of Latin America, Cheltenham: Edward Elgar.

  2. For some, the main flaws of Kirchnerism were the relative fiscal laxity, high inflation (resulting from expansionary macroeconomic policies,) and the absence of a more concrete industrial policy strategy. For example, Kulfas, M. (2016), Los Tres Kirchnerismos: Una Historía de la Economía Argentina, 2003-2015, Buenos Aires: Siglo XXI. For an alternative view that emphasizes the low rates of interest to accumulate reserves, and the absence of a more vigorous fiscal expansion to promote growth see Vernengo, M. (2019), “Una Salida Brasileña,” Página/12, 10 de octubre.

  3. For a discussion of the causes of informal dollarization in Argentina see Amico, F., Serrano, F. and Vernengo, M. (2022), “Cómo evitar el bimonetarismo y el monetarismo,” Le Monde Diplomatique (Cono Sur), octubre.

  4. For an explanation that this should have been expected after Macri’s election see Vernengo, M. (2016), “Neoliberalism Resurgent in Argentina: What to Expect after Macri’s Victory in Argentina,” Dollars & Sense, January/February.

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