Dollarisation of a different kind

Extraordinary times require extraordinary measures. Hence, the proposed dollarisation in Argentina

In recent years, there has been some de-dollarisation, with the trend most visible in Russia and China. Several other countries have also reduced the use of dollar in international transactions to varying degrees. This tendency is expected to continue. However, now suddenly a somewhat contrasting development is underway. It is dollarisation within a country.

To see this, let’s turn to Argentina, where people are sick and tired of the recurring very high inflation, and the usual policies. Inflation is at 113 per cent at present. Javier Milei, an important presidential candidate in the upcoming elections, has advocated replacing the peso with the US dollar. There is more. He proposes to abolish the Central Bank of the Argentina Republic (CBAR), which makes this dollarisation quite different. Mr Milei has some unconventional solutions for other problems as well. And, he is getting public support because of his stand, rather than despite it.

By abolishing the CBAR, Argentina would lose out on seigniorage. But, surprising as it may sound, there are ways to perform some of the functions of the central bank if the CBAR were to be abolished.

The dollar replacing the peso as the domestic currency could reduce inflation massively. If the interest rate needed to be changed to stabilise aggregate demand over an economic cycle, the government could use a tax-subsidy scheme to change the effective interest cost in the context of borrowing for real investment. Furthermore, the government could use a few reputed and well-capitalised commercial banks as its bankers. Also, the government could use an independent public debt office to manage the public debt. Finally, in case of excessive international capital inflows or outflows affecting the quantity of dollars in Argentina, the consequent changes in the price level could to some extent provide the adjustment mechanism to change the needed balance of trade. The government may also use a tax to stabilise capital flows.   

In the absence of the CBAR, the government could act as the lender of last resort for banks. For this purpose, it would need to buy a credit line to ensure liquidity when needed. Finally, it would need to have enough dollar notes to begin with so that the peso could be dropped as the currency (it is assumed for simplicity that the usual currency demand is constant).

How will Argentina get all the dollars needed? First, many Argentinians hold dollar assets abroad. Second, many dollar notes are in circulation already in Argentina. Third, many Argentinians have been using dollar notes as assets for their savings. It is possible to bring much of that money to the surface and in circulation in Argentina. This is not unrealistic, given the broader new policy setup proposed by Mr Milei. The amount mobilised can be substantial, but still inadequate. Argentina may still need to borrow.

Given that Argentina is already heavily indebted to the International Monetary Fund (IMF), it would need to look elsewhere. Fortunately, for Argentina, there is a trend of de-dollarisation. So, there is a potential interest for the US in the possible dollarisation within Argentina. This is, in a way, a reversal of de-dollarisation. So, it can be in the interest of the US to step in.

Suppose that the US prints new dollar notes against securities issued by the Argentina government (with some coordination with the IMF and the US legislative body). And, the US extends a credit line to the Argentinian government so that it can indeed act as the lender of last resort, if required. It is envisaged that the dollar becomes the legal tender in Argentina and the new dollar notes are given in exchange for pesos at a realistic rate.

The proposed dollarisation would limit the supply of dollars relative to demand in Argentina and relatedly the expectations on inflation would change dramatically. So, inflation could drop massively in the country. Inflation in the US would remain unaffected as the additional dollars would be used abroad.

At a later stage, the government in Argentina could set up a central bank afresh as an altogether new institution with no historical baggage. This new central bank could issue a new domestic currency; the public authorities could then make it the new legal tender. The dollars could be collected from the public in exchange for the new domestic currency. The public authorities could use the dollars that are collected to repay the loan to the US. Argentina incurs the interest cost on the loan.

This column has spelt out the broad contours of a second-best solution in the context of a country like Argentina, given its history. It is, of course, not a general solution for all countries.

The writer is an independent economist who has taught at Ashoka University, ISI, and JNU.  gurbachan.arti @gmail.com Nikhil Vuyyuru contributed to the column