Carlos Menem was elected president of Argentina in May 1989. For the previous 45 years, Argentina had witnessed unstable, slow growth and rampant inflation. As if to salute Menem, a bout of hyperinflation broke out the month he was elected president. It peaked in July 1989, when the monthly inflation rate reached 197%. As if that weren't enough, the economy, according to Domingo Cavallo, Menem's economy minister, “was so complicated that not even experts could understand what was happening.” Anomie prevailed.
President Menem began cleaning the stables, but at first, progress was slow. In late 1989, one of us (Hanke) met Menem for the first time. During that meeting, I advised Menem that until he ended hyperinflation and stabilized the economy, he would not be seen as trustworthy and would not have the public's trust. Without this credibility and trust, he would not be able to move forward with his economic modernization plans.
At the request of President Menem, I co-authored a book, '¿Banco central o caja de conversion?' [‘Banco Central ou casa de câmbio?’, em tradução livre], with Kurt Schuler, while he worked with me as a postdoctoral researcher at Johns Hopkins. We present a plan for an orthodox monetary board. This would have replaced Argentina's central bank (BCRA). And, unlike the BCRA, it would not have the capacity to engage in monetary policy; it would have only one exchange rate policy: the peso-US dollar exchange rate would be fixed, and the rate would be reliable because the peso would be fully backed by US dollar reserves. A draft of our book was circulated in Buenos Aires in 1990 and was published by Fundación República in early 1991.
To stop triple-digit inflation in Argentina, the Menem administration decided not to introduce a currency board, but rather a convertibility system, which pegged the peso to the US dollar at a rate of 1:1. This happened on April 1, 1991. Although convertibility stopped inflation and laid the foundation for an economic boom, it was managed by the BCRA, which had the ability to engage in discretionary monetary policy. For me, this capability was the Achilles heel of convertibility. The BCRA's discretionary powers were equivalent to placing a bottle of whiskey next to a recovering alcoholic. Shortly after the introduction of convertibility, I wrote an opinion piece in Wall Street Journal“Argentina Should Abolish its Central Bank” [A Argentina deveria abolir seu Banco Central]in which he argued that convertibility was not a currency board and that unless the BCRA's power to engage in discretion was removed, convertibility would eventually collapse.
Sure enough, in 1998, convertibility began to show signs of trouble. Menem again called me for advice and requested a dollarization bill. Kurt Schuler and I published “A Dollarization Blueprint for Argentina” [Um plano de dolarização para a Argentina] on February 1, 1999. Unfortunately, dollarization never became law. As they say, the rest is history. Indeed, Argentina has faced one currency crisis after another since convertibility was abandoned amid political and economic chaos in 2002.
This brings us to the newly elected president of Argentina, Javier Milei. The scope and scale of the economic problems he faces are largely the same as those Carlos Menem faced 35 years ago. Although it is not hyperinflation, Argentines have suffered from triple-digit inflation since February last year.
President Milei campaigned promising to end inflation by abandoning the BCRA and the peso and replacing them with the US dollar. It seemed that he had learned a great lesson from Menem, namely that to become credible and gain public trust, inflation must be crushed.
But, once in office, Milei postponed dollarization, promising that it would arrive at some future, unspecified date. Apparently, Milei was scared off by a chorus of experts, including his own, who claimed that dollarization was not viable without receiving a large loan, because Argentina did not have enough foreign exchange reserves to dollarize.
This is regrettable and could condemn Milei. It turns out that the choir of experts is singing from a faulty song book. To dollarize, the only thing that must be physically converted into US dollars is Argentina's stock of peso notes and coins. To make this conversion, the gross foreign exchange reserves in dollars must exceed the value of the stock of notes and coins in pesos at the exchange rate decided at the time of dollarization. All other assets and liabilities by weight are simply nominal claims or IOUs [“IOU” (abreviado da frase “I owe you” – eu devo para você) é geralmente um documento informal reconhecendo uma dívida] which can be expressed or redenominated at any time in any unit of account or currency. They are not physical units that need to remain intact until their expiration date.
As of December 31 and at Argentina's official exchange rate, the BCRA reported “International Reserves” of 18,654 billion pesos (US$23.1 billion), significantly more than the 7,435 billion (US$9.2 billion) in “Banknotes and Coins in Circulation”. Therefore, the stock of uncommitted gross net reserves is more than adequate to successfully convert Argentina's stock of peso banknotes and coins into U.S. dollars. The experts are clearly wrong.
How can so many experts be so wrong? First, they failed to realize that, with the exception of peso notes and coins in circulation, only a stroke of a pen is needed to redenominate peso assets and liabilities into US dollars. As a result, they exaggerated the amount of exchange that would be needed to dollarize Argentina.
If that were not enough, most experts believe that dollarization can only occur when a country's net international foreign exchange reserves are adequate. But when determining the feasibility of dollarization, the value of gross international net exchange reserves ends up being irrelevant. It is the gross net foreign exchange reserves that are relevant, not the net reserves.
Contrary to the shortcomings of the currency arguments that scared Milei, our analysis is based on sound economics and first-hand experience. In fact, one of us (Zalles) served as an advisor to the president of Ecuador, Gustavo Noboa, when he dollarized. And we both served as advisors to Ecuador's minister of economy and finance, Carlos Julio Emanuel, who was responsible for the final implementation of dollarization.
At the time Ecuador was dollarized, its gross net uncommitted reserves were US$872 million. This was enough to cover the US$578 million supply of banknotes and coins in sucres. Interestingly, at the time of dollarization, Ecuador's net international exchange position was negative. In fact, Ecuador's net reserves were negative at US$619 million.
All the talk and writing about the unfeasibility of dollarization in Argentina due to the lack of international dollar reserves is simply wrong. Official dollarization in Argentina is desirable and viable.
Until he pulled the trigger and introduced convertibility to end inflation, President Menem was going nowhere. Once inflation was crushed, Menem's modernization reforms began to advance. Menem's message to Milei is clear: To be successful, a monetary reform to end inflation must come first, not last.
Steve H. Hanke is a professor of applied economics at Johns Hopkins University in Baltimore, Md., and a senior fellow at the Independent Institute in Oakland, California. As chief advisor to President Milo Dukanovic, Hanke designed and implemented the “dollarization” of Montenegro in 1999 and was an advisor to Ecuador's minister of economy and finance, Carlos Julio Emanuel, when Ecuador wa
s dollarized in 2001. He advised Argentine President Carlos Menem from 1989 to 1999.
Francisco Zalles is an adjunct academic at the Ecuadorian Institute of Political Economy. He served as an advisor to the president of Ecuador, Gustavo Noboa, and later to several ministers of economy and finance, including Carlos Julio Emanuel, when Ecuador was dollarized in 2001.
©2023 National Review. Published with permission. Original in English: A Message from Menem to Milei: Dollarize Argentina Now
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