Can dollarisation save an economy? | Explained

. Argentina's recent presidential election saw the victory of Javier Milei, whose unconventional and worrying views, such as his opposition to abortion and ambivalent attitude towards the military government, have drawn attention. His economic proposals, such as replacing the peso with the dollar and eliminating the Central Bank, have also been debated. Dollarisation can act as a solution to hyperinflation, incentivising the economy to focus on export successes and easing conditions for foreign capital. Experiences of some countries, such as Ecuador, hold out promise for the project of dollarisation, with the economy showing considerable progress since 2000. However, the adoption of an external currency without the ability to chart independent policy can be seen in the case of Greece, where crushing austerity was adopted in exchange for financial assistance. Dollarisation is not a silver bullet, but if used well in conjunction with nimble domestic policy, can offer a route to success.

Another election, another victory for the global right. Javier Milei, the recent winner of Argentina’s presidential election, has drawn attention for his unconventional and worrying views, such as his opposition to abortion and his ambivalent attitude towards the torture and undemocratic excesses of Argentina’s military government.

Mr. Milei’s economic proposals have also drawn much debate and scrutiny. The self-confessed “anarcho-capitalist” pledged in his campaign to replace Argentina’s currency — the peso — with the dollar, to eliminate the Central Bank and to slash government spending. Suffering under inflation in excess of 100%, and with nearly two-thirds of the population falling below the poverty level as purchasing power of wages and salaries have eroded, the electorate has chosen to throw their weight behind Mr. Milei’s idiosyncratic policy proposals.

However, the president-elect has already begun walking back on some of his campaign promises, claiming dollarisation as a “medium-term” goal and ruling out the immediate lifting of currency controls when he takes office. Whether dollarisation can be achieved immediately and painlessly is an important question, given the scarcity of dollar reserves with the Argentinian Central Bank. Regardless, the question of whether dollarisation is a solution to an economy undergoing runaway inflation is an important one.

Dollarisation can act as a solution to hyperinflation by breaking the feedback link between rising prices and rising money supply. If the domestic currency is replaced by dollars, so the theory goes, money supply can no longer be controlled by vested political interests who can increase spending for political ends. The incessant rise of prices would be forced to moderate since consumers would no longer be able to access currency easily, thus slowing down consumption demand.

Dollarisation can also have positive effects on growth. Since a small economy can only access dollars through foreign trade and/or capital inflows, it would incentivise the economy to focus on export successes and easing conditions for foreign capital, who would be more willing to invest in an economy with a stable currency. The stable value of the dollar would ensure that economic agents —both foreign and domestic — would be able to make long-term plans regarding economic activity, plans that would otherwise not be possible under a currency that rapidly lost value.

There are some potential problems. The adoption of dollars as a currency implies that economies lose an important source of policy leverage, with monetary policy now unable to control money supply. On the foreign trade front, countries would no longer be able to take recourse to depreciation to boost exports, focusing only on export promotion to stave off downturns. Some proponents of dollarisation see this as a positive outcome, since it would ensure the government resorts to productivity boosting methods to combat recessions, instead of changing exchange rates.

Theory aside, the experiences of some countries hold out promise for the project of dollarisation. Three fully dollarised economies — Ecuador, Panama and El Salvador — have had successful economic outcomes following dollarisation, with Ecuador a useful case study. The Ecuadorian economy suffered a series of debilitating crises in the late 1990s, with economic output contracting by almost 7%, inflation at roughly 67%, and the domestic currency, the Sucre, depreciating by almost 200% in 1999. President Jamil Mahuad announced the adoption of the dollar in January 2000; widespread protests following the move forced him to resign two weeks after the announcement. Despite this political upheaval, Ecuador persisted with dollarisation.