Argentina Needs to Dollarize

Argentina Needs to Dollarize

Another currency crisis is roiling Argentina, and a year ahead of an election President Mauricio Macri is struggling to right the ship. The peso has lost half its value against the U.S. dollar since January. Inflation expectations are soaring.

The central bank has boosted its overnight lending rate to an annual 60% to try to stop capital flight. But Argentines are bracing for spiraling prices and recession. According to Alberto Ramos, head of Latin American economics at Goldman Sachs , markets now expect the economy to contract more than 2% this year and inflation to top 40%.

The question that seems to be on everyone’s lips: Why is this happening again, under a president who is supposed to embody change? The answer: Because Argentina still has a central bank. To fix the problem once and for all, it should dollarize.

It is worth pointing out that the troubles have been brewing for some time. On a trip to Buenos Aires in February, I got an earful from worried economists who said Mr. Macri was moving too slowly to reconcile fiscal accounts.

In 2016 and 2017 the government continued spending beyond its means and borrowing dollars in the international capital markets to finance the shortfall. That put pressure on the central bank to print money so as not to starve the economy of low-priced credit ahead of midterm elections in 2017. It was a risky strategy since it was obvious that the sun would inevitably set on the U.S. Federal Reserve’s easy money policy.

A sharp selloff of the peso in May was followed by a new $50 billion standby loan from the International Monetary Fund in June. With a monetary base that is up over 30% since last year, in a nation that knows something about IMF intervention, that was like waving a red cape in front of a bull.

The peso was thus vulnerable when currency speculators launched an attack on the Turkish lira last month and the flight to the dollar spilled over into other emerging markets, including Argentina. After decades of repeated currency crises, Argentines can smell monetary mischief. A peso rout ensued.

There were strings attached to the standby loan. The fund told the central bank to reduce the stock of its short-term, high-yield domestic debt—known as Lebacs—because it is expensive to service. Not rolling over that debt meant unleashing more pesos into circulation, which would be inflationary. But the IMF limited Argentina’s capacity to use the dollars from the loan to sop up those reserves.

The Argentine treasury was instead supposed to issue new debt. It did so, but not to the extent necessary in the midst of a crisis. Plus, markets understand that putting more pesos into government coffers is not the same as extinguishing them.

The bank raised reserve requirements and interest rates, but the panic was on. The demand to hold pesos has collapsed.

Mr. Macri rattled markets in late August when he said he would ask the IMF for the next disbursement of the standby loan early. The peso swooned again.

Argentine Finance Minister Nicolás Dujovne spent two days at the fund in Washington last week, and on Wednesday he expressed optimism about his boss’s request. The deal to release the funds early, Mr. Dujovne said, could be voted on this month.

The peso rallied a bit on the news. Yet as any Argentine understands, an IMF package can’t cure what ails the peso.

This is a long-term political problem that has manifested itself in repeated economic crises since the mid-20th century. The government lives beyond its means while taxes and regulations, particularly on labor, make many businesses uncompetitive. The net effect is always the same: ballooning debt and a lethargic economy followed by devaluation or default or both.

Mr. Macri has sought to heal the country from the polarization that flourished during the left-wing populism of his predecessor, Cristina Kirchner. In the early years of Mr. Macri’s presidency, he emphasized reconciliation and shied away from telling the nation how big a mess he’d inherited. He also wanted to avoid a clash with the organized special interests that have a history of going to the streets and using violence to protect their privileges.

Mr. Macri has managed to cut back on electricity, water, gas and transportation subsidies, but the fiscal deficit—including provinces and municipalities—will still be around 5.5% this year and 3.5% in 2019, according to Aldo Abram, a director at the Buenos Aires think tank Libertad y Progreso. More reforms are needed, and the risk of a political and social upheaval is real.

The fastest way to restore confidence would be to put an end to the misery caused by the peso and to adopt the dollar. Argentines could then get on with the business of saving and investing in their beautiful country. Mr. Macri has tried gradualism. Now is the time to be bold.

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