Monday, November 20, 2023

Dollars & Nonesense: Milei and the risk of hyperinflation

Javier Milei will be Argentina’s next president. Milei is an extreme right-wing populist, with authoritarian, some may say Fascistic, tendencies. He is an admirer of Trump and Bolsonaro. He is rumored to talk with his deceased dog, that he had cloned. His party’s proposals range from the dangerous – like dollarization, the closing of the Central Bank, the drastic reduction of social spending, the loosening gun ownership laws, and the criminalization of abortions – to the insane – like instituting a market for human organs, or allowing fathers to opt out of the paternity obligation to pay parental support. Some of his views are outright despicable, like his minimization of the human rights violations of the last dictatorship. He has also has played fast and loose with all his proposals, suggesting that he may not do anything that he promised to do, with the exception of one. He has maintained that dollarization is not negotiable.

The dangers of dollarization could not be minimized. Dollarization implies getting rid of the domestic currency, and being forced to borrow only in dollars. Debt in foreign currency can only be repaid with the dollars obtained from exporting, which would limit drastically the ability of the government to borrow, in particular since Argentina is already deeply indebted with the International Monetary Fund (IMF) and private creditors, as a result of the presidency of Mauricio Macri. Macri is Milei’s main political sponsor within the Argentine establishment, and during his presidency he more than doubled the debt in foreign currency (on Macri see this paper). If the idea is to dollarize to reduce debt accumulation and the problems associated with it, it must be noted that to eliminate the central bank and the peso as the legal tender for domestic transactions does nothing to increase the exports needed to service foreign debt, which would be the only way to obtain more dollars.

If the idea is to dollarize to stop inflation, which it might do, it would only be reasonable if inflation, which is running at almost 140 percent annually, was caused by the central bank and the printing of pesos. In fact, Macri believed that was the problem, and promised to stabilize the economy back in 2015, when inflation was around 25 percent. The president of the central bank appointed by him, Federico Sturzenegger, a possible finance minister of Milei, instituted inflation targeting and prohibited the monetary financing of the Treasury. However, inflation still more than doubled and was at 50 percent at the end of Macri’s government. The reason for that is that inflation results from the depreciation of the peso, which raises the price of imported goods, and leads to demands for higher wages. Dollarization may resolve the problem by essentially precluding any depreciation of the currency.

To dollarize Milei will need to obtain large amounts of dollars. And if the dollars are obtained, the central bank could intervene in the foreign exchange rate market, stabilize the currency and stop inflation. In other words, dollarization is only possible in a context in which it would not be needed anymore. Dollarization would reinforce the problem, already exacerbated in the Argentine case, of borrowing in foreign currency.

The risk now is that Milei might announce his dollarization plans, and markets might  anticipate it, and a rush to the dollar might follow. In fact, Milei has openly said that the more the peso depreciates the better. He suggested that he would allow the exchange rate to depreciate as much as possible before dollarization, essentially causing a hyperinflation. He would cause the whole economy to collapse in order to stabilize it. He would cure the disease, but kill the patient.

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