Dollarization of the economy: magic does not exist

Argentina is experiencing a very interesting debate regarding its monetary future: to dollarize the economy or not? The origin of this possibility has its most powerful root in the alternative of providing the country with a remedy against inflation, a phenomenon that has not been reversed for decades.

Dollarization, among other things, implies assuming the US dollar as legal tender.

The BCRA could not carry out an active monetary policy influencing the quantity of money, interest rates, and credit policies, nor could it actively influence the exchange rate, and gradually in the dynamics of the transformation, until the economy was fully dollarized, in the end. the weight would be gone.

In short, the Argentine government would lose tools that the vast majority of countries use to control the economy depending on the phases of the economic cycle in which the country finds itself.

The argument in favor of regime change stems from the lack of institutional maturity to use monetary, exchange and fiscal tools responsibly. Hence, it seeks to “corset the possibility of issuing pesos” to finance the public sector deficit and thus control inflation.

It is a harsh rule that has a clear benefit: lowering and aligning inflation at a high cost, which is losing tools to manage the country’s economic policy.

A not minor issue of dollarization is What exchange rate would it be? Assuming that it could be a value close to $890 per unit, according to one of the scenarios of the analysis of the CentroRA of the Faculty of Economic Sciences of the UBA, it will initially have an impact by increasing the prices of national and imported goods.

This would generate an initial inflationary effect, also affecting the fall in income and real wages, company valuations, and assets in general in the economy.

Therefore, at the beginning of dollarization, when the costs of imported inputs rise, and the prices of goods in general, added to the retraction of supply, with a decrease in demand due to the drop in income, will inevitably lead to a recession.

The entire financial system will have to transfer the credits taken and granted in pesos to dollars, which will generate a significant transaction cost until an agreement is reached on how and at what price debtors and creditors will be able to face the new value of their assets and liabilities.

Then it will be necessary to think about the activation of exports, which will depend on the competitiveness of the dollar with the rest of the international currencies, but mainly on the use of production factors.

The inflationary process, which has been going through at a high speed, would tend to gradually decrease.

A feasible scenario would be the decision of the US Federal Reserve to raise interest rates, if problems persist to reverse high inflation. This would cause the dollar to appreciate against the rest of the currencies, which would materialize in less competitive Argentine exports.

In this case, imports become cheaper, increasing the demand for goods and services from the rest of the world that are used in industry and for final consumption, which would generate pressure to obtain debt to have the necessary dollars.

Dollarization per se does not solve the future of the country, it is not magic, but it induces us to do our homework at the macroeconomic level, this means framing the fiscal deficit, generating institutional stability, having clear rules for all the actors in the economy, particularly for foreign tradein order to recreate confidence, lower the cost of credit and attract foreign investment.

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