A MATTER OF STRATEGY IN ARGENTINA
MILEI AND DOLLARIZATION
THE DANGEROUS SITUATION
The Mandate
Javier Milei of Argentina was elected with three mandates: to reduce the inflation rate by stopping monetary creation, to reduce the fiscal deficit to eliminate the reason money was created, and to reform the economy to make it more prone to growth. The three mandates are interrelated. The strategic question is in which order the mandates should be implemented.
During the campaign, he repeatedly emphasized that the first things he would do would be to close the Central Bank and dollarize the economy. The other two things would be done once the economy had been dollarized. He even appointed Emilio Ocampo as the head of the Central Bank in charge of closing it in case he won the election.
Yet, as soon as he won, it became evident that his priorities had changed. He appointed Luis Caputo, Secretary of Finance, Minister of Finance, and President of the Central Bank in the administration that started the current crisis as the Minister of the Economy. Milei and Caputo put in place a new strategy that began with the transfer of the legislative functions to the executive branch, the immediate elimination of the fiscal deficit, and the liberalization of the economy. Dollarization was left for the future.
Ocampo left. The peso has remained in place and has become a pivotal instrument to stabilize the economy. Or so was the idea.
Milei and Caputo used the peso for the same purposes as their predecessors: to extract a tax from the population without passing it through Congress. The tax they imposed on the holders of peso assets, wages, and pensions was massive: a devaluation of 50% and an increase of inflation to 232%, the highest in 32 years. The monthly inflation increased from 12.8% in November to 25.5% in December.[1] Milei had attacked his predecessors for using the currency for this purpose as robbery, yet he is doing the same. In a television interview, he warned he would do this but tried to justify it, asserting that the result would be the end of inflation.
The people most affected by this terrible tax (taking away 50% of the purchasing power of your deposits in pesos, your wages, and your pensions in one go) were the salaried people and the pensioners, which is, the middle class, or, more precisely, the former middle class. The strategy has a psychopathic logic. Think of a cattle farm that is spending more than its revenues. The reasoning is like stopping feeding the cattle for two or three months to reduce costs and balance the accounts of the enterprise, and then resume feeding the cattle, hoping that it will still be there and that this ugly solution will not have to be applied again.
The Rasputin Strategy
On February 22, 2024, Veronica Smink of the BBC wrote an article about the two faces of the adjustment that President Milei is carrying out in Argentina.[2] On the one hand, the Ministry of the Economy announced that it had attained a fiscal surplus for the first time in over a decade. On the other hand, the Social Debt Observatory of the Catholic University of Argentina estimated that poverty increased from 49.5% of the population in November to 57% in December, the worst since the 2001-2002 crisis. This happened as a massive 50% devaluation carried out by Milei eroded the purchasing power of the peso much faster than under the previous regime. The monthly minimum salary hit $160 (the second worst in Latin America).
According to the BBC article, the Argentine Confederation of Middle-Sized Enterprises (CAME) estimated that Milei´s inflation tax reduced pensions by more than 38%. The same tax also reduced public salaries by 27%, economic subsidies by 64%, and public works by 86%. As a result of the reduction of subsidies, public transport prices increased more than 200%, and electric tariffs increased between 65% and 150% in reverse relation to income (those with lesser incomes had received higher subsidies, now eliminated). All in one go. An economic consultant, Focus Market, told BBC that retail sales fell 26.8% in January and overall consumption by 18.5%. People cannot afford what they produce.
Milei’s inflation tax is devilishly efficient because it falls on pesos, and people cannot move away from them because he kept a measure established in 2011 called the “cepo” (clamping table, an instrument of torture), which restricts public access to foreign currencies. So, people cannot avoid paying the inflation tax.
Of course, people holding dollars do not pay the tax.
Moreover, people living in the dollar world do not pay this tax even if they don’t have physical dollars. For example, if you are a landlord, you set your rental prices in dollars, even if they are payable in pesos at the current exchange rate. Every month, you receive more pesos in revenues. If the devaluation reduces the purchasing power of the peso by half, you receive twice the number of pesos. The same is true if you sell things with prices that go up with inflation. The value of your inventories and the sales revenues increase as the price level increases. Only those whose assets or revenues are denominated in pesos (wage earners, holders of government bonds, and pensioners) pay the tax. They are the cattle. The adjustment is on their backs.
This procedure could be called the Rasputin strategy. Rasputin said that to purify the soul, one must sin to perdition. Milei uses the old peso strategies he attacked so much to kill the desire to sin for good in this form. He is restricting economic freedoms (particularly access to foreign exchange), but he says he is doing so to give liberty to the population. All their predecessors thought the same. They never did the things Milei is doing with the purpose of launching uncontrollable inflation. They used it to tax away the purchasing power of the population and then stabilize the economy. But then they lost control of the process, something that could happen to Milei. The drama will not end with the stabilization after eliminating the fiscal deficit at today´s ratio of salaries to prices. Milei already declared that the worst is coming. Its peak will be around March or April.[3]
The Rasputin strategy is overshooting and spreading the cost of the adjustment in a perverse way that cannot be justifiable for a libertarian because it is based on restricting the freedom of a certain group to denominate their assets and revenues in dollars. A true libertarian would not do this, much less if he allows others to denominate them in dollars. The strategy could be called Orwellian as well. All animals are equal, but some animals are more equal than others.
The Pending Adjustment
As I mentioned, the January fiscal equilibrium is unsustainable because it has been attained with unrealistically low salaries. With the April salaries worse than today`s, the economy would slow down further due to declining demand. If feeding is not increased, the cattle will die, and the farm will collapse. Yet, the problem is more complicated than this, not only because some of the cattle may die in the process but also because, from that moment on, you cannot keep on giving the cattle practically nothing to eat. Argentina cannot survive if, as is happening now, salaries are kept fixed while prices are increasing at 232%. Even if the economy stabilized today, the wages would not be enough to buy the things Argentina produces. It would be much worse if prices kept on increasing.
The wage is utterly underappreciated under two key measures: its real and dollar equivalents. Much has been said about the Argentine stagnation. Still, when measured in real terms (which is, adjusting for price inflation) at purchasing power parity (PPP, taking into account the purchasing power of the peso inside Argentina), its 2022 GDP per capita was the fourth highest in Latin America.[4] It is 37% higher than the regional average. Its salaries in dollars could not be at the level of Venezuela, the lowest in the region, and it is absurd to think that they could be insufficient to buy essential goods and services for a family. In his desire to cut demand for dollars, the Milei devaluation left the peso grossly undervalued. Now you can buy Argentina for a tango…but only if you have dollars—something that Milei does not allow Argentines to get.
Since this left wages too low, they will have to rise again to equilibrate the economy, in both dollars (when compared with those of other countries) and real terms (when measured in terms of their domestic purchasing power). Thus, the Rasputin strategy led to the need for wage inflation. After a period of higher devaluation than inflation, Argentina needs a period of higher inflation than devaluation—a currency real appreciation. This, of course, may lead to general inflation as well. If wage inflation is repressed to avoid this danger, production will collapse to the purchasing power of the prevailing low salaries. Argentina would become further impoverished and in a more permanent way because enterprises would fail.
That is, Milei has painted himself into a corner from which he will find it difficult to escape.
The Reforms
In early December 2023, Milei sent to Congress a DNU, a “Decreto de Necesidad y Urgencia” (Decree of Necessity and Urgency), demanding the legislative authority to be transferred to the Executive Branch—to himself and decreeing more than 300 reforms to more than 70 laws.
The Labor Law was among the laws that would be changed if the DNU was approved. The trade unions presented a recourse to a federal court, which declared these changes unconstitutional. The reasoning used by this court to reject the Labor Law reforms (that no obstacle or urgency was preventing Milei from passing it through Congress) made it clear that every part of the DNU could be defeated in court. There was no chance that Congress would transfer its legislative authority to Milei. Argentina would remain a liberal democracy with a separation of powers. Milei accepted the sentence and initiated negotiations with the opposition to get the necessary votes to approve the reforms included in the DNU. He won an initial general reading of the laws contained in the DNU. Yet in a second reading, article by article, Congress made so many vital deletions that Milei thought they emasculated the reforms he proposed and withdrew them. The long-term reforms are now paralyzed, and full attention is given to stabilizing the economy. Milei’s success depends on his ability to do it. He needs such stabilization to convince the population that his ideas are credible.
The Political Economy
The political situation is very fluid. In the early days of Milei’s presidency, the population seemed ready to give him a chance to carry out drastic reforms, which would initially cause severe discomfort. Milei warned them very clearly. However, Milei seemed to have overestimated his chances in at least one dimension: he thought people would pressure their deputies in Congress to grant him legislative powers. A federal court stopped him. In the immediate future, we will know if he also overestimated the population’s will to absorb the adjustment concentrated on wage earners and pensioners.
At this moment, Milei is in a situation that no politician would look for: he has taken measures to stabilize the economy that are causing severe damage to a vast segment of society in the short term and is proposing a series of long-term reforms that will take away many entitlements that these crucial groups have enjoyed for many decades. He has declared that the peak of pain will be reached in March or April and that from that peak on, stabilization will take place gradually. So, even in the best circumstances, the adjustment will take long months, during which he would use means that contradict his avowed ends of opening Argentina to liberty. It is like driving a speeding car on an icy road.
The situation is progressively tricky because he is asking for support on his path even if his policies have not produced a single success at this point.
AN ALTERNATIVE STRATEGY
Steve Hanke’s Proposal
Milei was right during his campaign when he insisted that he had to stabilize the economy first thing on the morning of his inauguration. Stabilization is essential for the economy to work normally and be ready to take the long-term reforms to make it sustainable. It is also necessary politically. With a success like that to his account, he would gain the credibility of the deputies to approve his long-term reforms. The deputies would not want to oppose the reforms proposed by a successful president. Without this success, even if it is just delayed, the approval of these reforms and even the success of the stabilization measures would be in danger—as they are now and more.
This is not the time to cry over the spilled milk. The question is what to do now to avoid derailing the attempt to stabilize the economy. The answer is to take the original path. Steve Hanke just published a short proposal first to stabilize fast, then to privatize the state-owned enterprises to attract heavy dollar investments to Argentina, capitalize the government, and improve their productivity, and then, from a position of strength, negotiate the long-term reforms.[5]
It is essential, then, to stabilize the economy as fast as possible.
How do you stabilize fast?
The only instance of instantaneous stabilization in Argentina's history is the introduction of the Convertibility Plan under the presidency of Carlos Menem. The Convertibility plan established a rule for the Central Bank: it could print money only when selling pesos for dollars at a perpetually fixed exchange rate (which was one-to-one). Period. Thus, there would be a dollar in reserves in the Central Bank for every peso in circulation. If the rules are followed, this system produces results similar to dollarization because it removes the discretion to create money from the Central Bank. The domestic currency increases only when dollars are brought from abroad.
The system stabilized the economy instantaneously, reduced interest rates, and produced the best macroeconomic environment in Argentine memory. The problem was that the Central Bank did not follow the rules and eventually started to print money to finance the fiscal deficit. This turned Argentina back to its sad past. Pesos rapidly became excessive, the Central Bank's dollar reserves went down, capital flew out of the country, and the system collapsed.
They said that the system had failed. The system was discarded forever.
The system had not failed. What had failed had been the will to follow the rules. But a lesson was learned: institutional discipline is weak in Argentina, and you’d better consider this in designing reforms. Thus, you need the real thing: the dollar rather than convertibility. Experience shows that while taking pesos from people in exchange for dollars is easy, it is tough, like extracting a tooth, to take dollars from people and pay them with pesos. Dollarization is not a system protected by bureaucrats' care; the dollar holders defend it. Thus, different from convertibility, dollarization is naturally robust. Of course, a future government may prohibit the circulation of dollars, but only at an extremely high political cost.
Thus, dollarization is the best system for a country that has failed many times over a century to carry out this simple task: stabilize the economy fast to avoid deepening the current crisis and keep the economy stable in the future.
Whenever dollarization has been proposed, many economists object that it is not a panacea and that many countries have stabilized their economies without dollarizing. Of course, it is not a panacea, like changing a flat tire is not either. Changing it would not improve your life in ways different from allowing the car to advance if pushed by any force. But if you don’t change the tire, you cannot advance. You need dollarization to stabilize and keep the economy stable. Not more than that. The point is that Argentina has been unable to do it for generations. Decade after decade, its institutions have failed to restrain the temptation to create money. Just outsource the provision of base money.
For people who remind me that inflation can be reduced without dollarizing, I should remind them that El Salvador reduced its inflation rate from 25% to international levels and became an investment grade in the 1990s without dollarizing. Under my watch as the Minister of Finance, inflation decreased from 10.5% in 1994 to 0.5% in 1999. The country became investment grade in 1997. El Salvador dollarized in 2001 not to reduce inflation but to reduce interest rates, a task in which it succeeded. Since then, its interest rates have been among the lowest in Latin America.[6]
Dollarizing
The discussion of this point has an ironic side because Argentina is already dollarized, only in an informal way that negates the benefits of formal dollarization. As we saw before, many contracts are denominated in dollars. Many people keep their resources in dollar bills and dollar deposits in Uruguay, Panama, and the United States. Yet, a substantial part of the population is captive to the government through the peso, which they are forced to use at a very high cost in inflation. Dollarization is just leveling the table for all Argentines. All of them should pay taxes under the same system. And, as the American revolutionaries said, “No taxation without representation.” Bureaucrats, not representatives, impose the inflation tax.
Many economists would say that the Argentines would take the dollars away. Yet, they will be happy to use dollars in their domestic transactions if they feel secure that their bank deposits and financial assets are denominated in dollars. They won’t need to hide them if they know the government is not establishing or keeping cepos or other tricks to take their dollars away. For this to happen, you only need to pass a law saying that all financial flows and contracts, including the banks’ entire balance sheets and income accounts, will be denominated in dollars, translating them from pesos to dollars at a certain exchange rate.
The Exchange Rate
Dollarization would provide the occasion to fix the underappreciation of the goods and services formerly denominated in pesos. This can be done by fixing the rate at which pesos would be exchanged for dollars. Such a rate can be estimated using the data collected to calculate the Purchasing Power Parity (PPP). The details of this calculation are simple but require a lengthy explanation that goes beyond this piece. It does not present unduly complex procedures. Steve Hanke has successfully used this estimation to calculate the approximate equilibrium exchange rate in cases like that of Argentina. This approximation massively facilitates the adjustment and permits the instantaneous stabilization of the economy. Once dollarized, inflation would rapidly converge to international levels. A stable economy would begin to resolve its problems, and politically, it would help to gain support to carry out the reforms needed to improve its efficiency.
The Fiscal Deficit
The fiscal deficit needs to be reduced. The rapid monetary stabilization produced by dollarization would help mightily because a large portion of the deficit comes from losses in the central bank that are caused and financed by printing money (think of the money that the central bank has been printing to pay interests to the banks that are extremely high because inflation is also extremely high). Moreover, reducing government expenditures can be realized more efficiently if you estimate it within stable prices. The same is true with any debt management, internal or external.
Privatization would help in two main ways: it would provide much-needed capital resources for the government to adjust its balance sheet and improve the efficiency of both the public and the private sector by introducing market incentives for the good management of the privatized companies. Their privatization would leave a nimbler public sector to concentrate on activities it can manage with a competitive advantage.
THE FLAT TIRE
These are not speculations. Dollarization has taken place in three countries in Latin America. Argentina has done something similar with the Convertibility plan, and it worked fine, except when the central bank started to violate its rules. Many articles have shown that contrary to what many say, Argentina has the dollars needed to dollarize (it is already informally dollarized). It is doable.
Milei was right when he insisted during his campaign that stabilization should be the priority in his government, meaning that it should be finished right after he assumed power. He was also right when he identified dollarization as the logical solution for a country that had failed innumerable times to stabilize the economy through self-discipline, even when establishing a convertibility regime.
When in power, however, he decided on a long path to stabilization that, in the best of cases, would take a long time to work, impoverish the country, impose an unnecessarily extreme pain on specific sectors of the population, and keep an also unnecessary level of risk of a return to high levels of inflation. The probability of this happening in the short term is high and even higher in the longer term.
The situation in Argentina is like that of a hemorrhaging patient. The bleeding must be stopped as soon as possible because nothing else is possible economically or politically while it continues unabated. Thus, dollarization would be the only solution available in this emergency.
To do it, Milei would have to stop listening to the dollarization-is-not-a-panacea (nobody has said it is) and the you-can-stabilize-without-dollarization crowds. He must change the flat tire and move the car with liberalizing reforms. As he goes today, he risks falling by the side as another president who failed to stabilize the country.
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Manuel Hinds is a Fellow at The Institute for Applied Economics, Global Health, and the Study of Business Enterprise at Johns Hopkins University. He shared the Manhattan Institute's 2010 Hayek Prize. He is the author of four books, the last one being In Defense of Liberal Democracy: What We Need to Do to Heal a Divided America. His website is manuelhinds.com
[1] Débora Rey, Argentina’s anual inflation soars to 211.4%, the highest in 32 years, AP, January 12, 2024, https://apnews.com/article/argentina-inflation-december-annual-milei-economic-measures-68f27bf0473590fabb5b6c1aff80579f
[2] Veronica Smink, Las Dos Caras del Ajustazo sin Precedentes de Milei en Argentina, BBC News Mundo, 22 de Febrero de 2024, https://www.bbc.com/mundo/articles/cnknnwqn4z3o
[3] BBC, Ibid.
[4] SOURCE: World Development Indicators, World Bank, https://databank.worldbank.org/source/world-development-indicators#
[5] Martín Kanenguiser, Qué le recomendó el halcón dolarizador de EEUU al presidente Milei sobre el FMI, infobae, 26 Feb. 2024, https://www.infobae.com/economia/2024/02/26/que-le-recomendo-el-halcon-dolarizador-de-eeuu-al-presidente-milei-sobre-el-fmi/
[6] See Manuel HInds, Would the dollars escape from a dollarized Argentina?, Substack, Febrary 24, 2024, https://manuelhinds.substack.com/p/would-the-dollars-escape-from-a-dollarized