Argentina's plan to abandon its currency. How will Javier Milei source the dollars?

Dollarization is not a new concept in Argentina, where successive administrations have been notorious for printing large amounts of money to cover budgetary shortfalls. This practice has led to surging inflation rates, which recently surpassed an annual rate of 140 percent, notes Dr. Carlos Solar, a Latin American specialist based at a London think tank. Past experiments of dollarization conducted in countries such as Ecuador, Panama, and Zimbabwe have had varying results, but a nation of Argentina's size has never attempted it before, analysts remark.

Dollarization entails adopting the dollar as the official means of payment and the standard unit of account. A country undergoes full dollarization when all local money is converted into dollars, and assets and contracts are denominated in US currency. According to the Bloomberg agency, any country can independently choose to dollarize its economy, without seeking approval from the US.

In countries where dollarization has been implemented, like Panama, Ecuador or El Salvador, most savings, reserves, deposits, and payments are dollar-based. Governments, and especially banks, obtain cash from the US Federal Reserve and the Treasury Department and then inject it into the local economy, explains Dr. Solar.

Private banks often have large reserves of physical dollars. This is further fueled by local citizens transacting in dollars and local businesses receiving dollar payments for their exports. The Federal Reserve is capable of sending USD abroad to replenish the country's cash flow. This fresh influx of money is then circulated back into the economy through loans issued by banks, who in turn charge interest, or using ATMs, adds the expert.

Moreover, tourists spending dollars on local services and remittances sent by family members residing abroad also bring money into these economies, Solar points out.

Bloomberg suggests that adoption of dollarization partly signifies a political surrender, reflecting lack of faith in the ability of elected and appointed officials to administer a stable fiscal policy.

By making this decision, countries forfeit their monetary policy tools, effectively placing them in the hands of the US Federal Reserve. The Fed focuses on the health of the US economy, paying no regard to economies such as Argentina's, Ecuador's, or Zimbabwe's.

However, dollarization does eliminate the risk of a local currency plummeting, which can reassure investors and reduce international loan costs.

In 2000, Ecuador swapped its native currency, the sucre, for the dollar after enduring an average annual inflation rate of 40 percent for a decade. Dollarization initially led to price spikes, but eventually, inflation virtually came to a halt and financial stability was achieved. The change, however, did not spur economic growth, Bloomberg adds.

"Without its currency and using the dollar, a country like Ecuador cannot print money. To earn more dollars, the country has to export more goods like bananas or chocolate to the US (...), or sell more oil than it imports. Therefore, a positive international trade balance is required to generate more dollars than expenditure, hence enabling economic growth and maintaining dollar liquidity," explains Sebastian Edwards, an economist at the University of California, Los Angeles, in an interview with NPR.

Edwards adds that many people he interacted with in Ecuador expressed a preference for the dollar over a return to the sucre.

Milei, who espouses extremely liberal economic views, likened the Argentine Peso's value to ice melting in the Sahara during his campaign. Observers recollect the 90s when Argentina's then-right-wing President, Carlos Menem, also proposed full dollarization, while rigidly attaching the peso's exchange rate to the dollar in an attempt to curtail inflation. However, this policy eventually led to failure.

Immediate dollarization is not expected to take place, at least not during the initial months of Milei's presidency. Most likely, he will introduce an exchange rate mechanism to balance inflation-reduction plans before the first results become evident, Solar predicts. In his opinion, the president's initial approach will involve dual-currency economic policy.

Milei's goal is to achieve a balanced budget by the end of 2024, intending to slash expenditures by about 15 percent of GDP. His plans are novel in the context of Argentina. However, he must tread pragmatically. He has set lofty targets that include stimulating economic growth, increasing wages and decreasing poverty rates. He is expected to face fierce resistance from left-wing politicians and trade unions in the sectors he plans to privatize, the RUSI analyst forecasts.