Argentina’s newly elected president has pledged to make the US dollar the legal tender, replacing his country’s currency, the peso. This is a process known as dollarization, in which a country replaces its currency with another country’s currency as legal tender. Argentina currently suffers from sky-high inflation of 140%, brought on by high budget deficits. Other economic problems plaguing this South American country are high interest rates, which are used to control inflation, increasing unemployment, and declining economic growth and living standards.
In the 1990s, Argentina faced a similar situation and entered into a Currency Board Agreement (CBA) with the US dollar, pegging the exchange value of its currency strictly to the US dollar (1 peso equals 1 US dollar). This was intended to reassure foreign investors and curb hyperinflation, but Brazil, its largest trading partner and economic rival, devalued its currency (the real) and allowed it to float freely. It worked well until 1999. Now faced with an overvalued peso (because it was tied tightly to the US dollar), declining export competitiveness, fiscal indiscipline (out-of-control budget deficits), and a recession, Argentina announced in January 2002 that It defaulted on a huge amount of foreign debt and was forced to abandon its CBA. Keep the US dollar and allow the peso to fluctuate. By September 2002, the peso had depreciated by 350% against the US dollar.
Under a Currency Commission Agreement or dollarization, the central bank of a country that rigidly fixes the value of its currency or adopts dollarization takes over its monetary policy functions; Central banks will cease to exist. its own legal tender. Domestic central banks are unable to fulfill their role as lenders of last resort to distressed domestic financial institutions, and have relinquished their authority to set domestic interest rates and control the exchange value of their own currencies. The partner country’s interest rate system becomes the home country’s interest rate system, and the exchange value of the foreign currency becomes the home country’s exchange value, so applying it to counter cyclical fluctuations in the domestic economy may have the opposite effect. For example, currently, the US central bank lending rate is at an all-time high (5.25-5.50%), while the inflation rate has slowed to about 4% or less. If the US inflation rate falls to 2%, the US Federal Reserve may start lowering lending rates to support its own economic growth. On the other hand, if Argentina has adopted the US dollar as its national or legal tender, in a situation where budget deficits, trade deficits, and inflation are rampant, lowering interest rates will only worsen the inflation situation and push the economy into recession. Adding to unemployment, social unrest and riots like those that occurred in the early 2000s.
Dollarization is most effective in small, open economies in which the United States is a major economic partner and with a history of poor financial performance and very unreliable economic policy. With the exception of Puerto Rico and the US Virgin Islands, most Central American countries, including Panama, Ecuador, El Salvador, and Guatemala, use the US dollar as their legal tender. Dollarization would eliminate foreign exchange transaction costs and the need for these countries to hedge foreign exchange risks, help them achieve inflation and interest rates similar to the United States, promote budgetary discipline, and reduce foreign exchange crises, foreign exchange and trade controls. , which has helped avoid international financial integration. .
The cost of dollarization in dollarized countries, which involves replacing their national currency with the US dollar, is estimated to be around 4-5% of the GDP of an average Central American country, apart from loss of monetary sovereignty and loss of monetary sovereignty. ing. The central bank rescues financial institutions that are in financial crisis. Argentina is certainly not a candidate for dollarization in its current circumstances. Exports to Brazil, its neighbor and largest trading partner, account for 25% of total exports, compared to only 1% to the United States. Its banking institutions also lack discipline and are highly inefficient. This country has a huge budget deficit and interest rates are extremely high.
vie for supremacy over the dollar
Dollarization is most effective between countries that are geographically contiguous and previously integrated through trade and other arrangements. For example, Mexico, Canada, and the United States are neighbors in North America and are united by the North Atlantic Free Trade Agreement (NAFTA). Yet they have their own currency because they don’t want to give up their monetary sovereignty. The Eurozone is another example of dollarization, with some countries in the European Union abandoning their national currencies in favor of a common currency called the euro starting in January 2001. These countries integrated not only monetary policy but also a whole range of economic policies. Policies including agricultural, labor, trade and investment policies that take advantage of geographic proximity and higher levels of trade integration. The same cannot be said for Argentina and the United States. The way forward for Argentina is not to pursue dollarization, but rather to restore fiscal discipline and reduce what is essentially wasteful spending, while at the same time exploring options to increase tax and non-tax revenues and improve the efficiency of the banking system. may seek opportunities to improve financial performance and restore fiscal discipline. Facilitate and diversify international trade through intra-regional and extra-regional free trade agreements; maintain interest rates high enough and long enough to control inflation; and where supply bottlenecks are the cause of inflation. is to improve the supply of primary products.
(The author is a former principal and associate professor of the Department of Economics, Loyola University, Chennai, and is currently a professor of economics at the Asian College of Journalism, Chennai.)
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