For Argentina, Dollarization May Work Better on YouTube Than in Reality

Argentina’s anarcho-capitalist president-elect is right that the country desperately needs dollars. But his economic plan for getting them may be the wrong one.

Javier Milei’s victory over Economy Minister Sergio Massa in Sunday’s presidential election showed how eager Argentines are to embrace change. The economy is in tatters, with inflation running at 143%. Milei, an outsider who became popular on YouTube and TikTok, has promised to “chain saw” public spending, eschew China-friendly overtures and, most eye-catchingly, “burn down” the central bank and adopt the U.S. dollar as the national currency.

Dollarization’s appeal is obvious. Argentine factories don’t have enough dollars to buy key imports, and have had to slash production and ramp up trade finance. The government owes $67 billion to international bondholders and $36 billion to the International Monetary Fund. With foreign reserves spent, it has had to borrow yuan from China to service repayments.

The IMF’s economic prescriptions have failed. While depreciating the peso to boost exports and curtail imports works in theory, the broad-based inflation created by the surge in imported costs has erased any gains in practice. The peso nominally has fallen by 92% since May 2018, but in inflation-adjusted terms it has appreciated 12%.

In emerging nations, most inflation comes from foreign exchange. Hyperinflation then erodes countries’ ability to raise taxes and leads to deficits and money printing. The IMF’s reform package is focused on addressing these issues, but they are closer to being symptoms than causes of the disease.

To cure it, the exchange rate must be stabilized. Dollarizing would certainly do the trick: Inflation in Ecuador, El Salvador and Panama, which all use the greenback, is at manageable levels.

Yet choosing the wrong conversion rate can be fatal. Also, the dollars needed to swap for all peso holdings are likely north of $9 billion, Capital Economics estimated in August, based on the black-market rate for the peso. Borrowing this money when the country can’t pay back the hard currency it already owes seems unfeasible.

And, as eurozone countries such as Greece famously discovered, giving up monetary sovereignty can make economic crises even more devastating. Default becomes more likely, not less. Argentina’s hard peg to the dollar between 1991 and 2002 already highlighted this.

Argentina’s Congress may end up watering down Milei’s policies to look more like those of pro-market leader Mauricio Macri between 2015 and 2019. Macri’s support after the first round of the elections was key to getting Milei elected, and the former president will presumably push to have his people in the new government.

But this isn’t very comforting. Macri’s solution to sourcing dollars was to borrow them without restraint from foreign investors, which triggered a crisis when the economy turned down in 2018. He then called the IMF instead of defaulting. Milei will need to renegotiate the IMF loan and do yet another bond restructuring, which the market has been pricing in for a while.

Ultimately, investors will keep getting their fingers burned on Argentina until supply-side reforms create a sustainable stream of dollars.

So far, the most that pro-market governments and the IMF seem to want to do is get rid of capital restrictions and the country’s system of multiple exchange rates tailored for specific sectors. While less than ideal, this exists for a reason. Argentina, as economist Marcelo Diamand described back in 1969, suffers from an “unbalanced productive structure.” It is the only nation in the world where agriculture is dozens of times more productive per capita than industry, World Bank data shows.

The off-the-charts fertility of the Pampas region brings in dollars, but that pushes the peso too high for the less-efficient manufacturing sector. A dependency on exports of soybeans, corn and wheat then makes the economy vulnerable to volatile global prices and droughts. These torpedoed the balance of payments back in 2018 and again this year.

Exploiting the Vaca Muerta shale formation may help, but Argentina ultimately needs to close the productivity gap through the kind of export-led industrial policies that have worked in South Korea and Vietnam. Populist recipes have failed to deliver these, and so will Milei’s.

Dollarization misses the point: If a nation can bring in enough dollars to make it sustainable, it is better off not dollarizing in the first place.

Write to Jon Sindreu at jon.sindreu@wsj.com