The eagerness of Argentines to accept change was demonstrated by Javier Milei’s triumph over Economy Minister Sergio Massa in Sunday’s presidential election. The economy is in complete collapse, and the rate of inflation is 143%. The outsider Milei rose to prominence on TikTok and YouTube. She has pledged to “chain saw” public spending, reject advances towards China, and, most strikingly, “burn down” the central bank and replace it with the US dollar as the official currency.

It’s clear why dollarization is appealing. Argentine industries have had to reduce production and increase trade financing because they do not have enough money to purchase essential imports. The International Monetary Fund is owed $36 billion, and foreign bondholders are owed $67 billion by the government. It has to borrow yuan from China to cover repayments because its foreign reserves have been depleted.

The economic advice given by the IMF has not worked. Although devaluing the peso in order to increase exports and decrease imports makes sense in theory, any practical gains have been negated by widespread inflation brought on by the spike in import prices. Since May 2018, the peso has decreased by 92% in nominal terms, while it has increased by 12% when adjusted for inflation.

Foreign exchange is the main cause of inflation in developing countries. Then, hyperinflation makes it harder for nations to increase taxes, which results in deficits and money printing. Although these problems are the main focus of the IMF reform plan, they are more like symptoms than the actual source of the illness.

Stabilising the currency rate is necessary to treat it. Dollarizing would undoubtedly work: The three countries that use the US dollar—Ecuador, El Salvador, and Panama—have acceptable rates of inflation.

However, picking the incorrect conversion rate can be lethal. Furthermore, based on the peso’s black-market rate, Capital Economics predicted in August that the amount of dollars required to exchange for all holdings in pesos would probably exceed $9 billion. It doesn’t seem possible to borrow this money when the nation can’t even pay back the hard currency it already owes.

Furthermore, as nations in the eurozone, like Greece, have well-knownly shown, ceding monetary autonomy can exacerbate economic problems. The likelihood of default rises, not falls. Argentina was already made clear of this by its strict dollar peg from 1991 to 2002.

Between 2015 and 2019, the Argentine Congress might wind up softening Milei’s policies to resemble those of pro-market leader Mauricio Macri. Milei’s election was largely dependent on Macri’s backing following the first round of voting, and it is expected that the former president will work to include his supporters in the new administration.

It’s not very consoling, though. In order to get dollars, Macri borrowed them freely from foreign investors, which led to a catastrophe in 2018 when the economy declined. Then, rather than default, he phoned the IMF. The market has been pricing in Milei’s need to renegotiate the IMF loan and undertake yet another bond restructuring for some time now.

Investors will ultimately continue to lose money on Argentina until supply-side reforms generate a steady flow of foreign exchange.

As of now, pro-market administrations and the IMF appear to be primarily interested in doing away with capital controls and the nation’s system of numerous exchange rates designed for different industries. Even though it’s not ideal, there is a purpose for this. Argentina has a “unbalanced productive structure,” as economist Marcelo Diamand put it in a 1969 description. According to World Bank data, it is the only country in the world whose per capita productivity in agriculture is hundreds of times higher than in industry.

The Pampas region’s incredible fertility generates dollars, but it also drives up the peso too much for the less productive manufacturing sector.

Due to its reliance on wheat, maize, and soybean exports, the economy is therefore susceptible to fluctuations in world prices as well as droughts. The balance of payments was destroyed by these both in 2018 and this year.

Although utilising the Vaca Muerta shale formation could be beneficial, export-led industrial strategies that have been successful in South Korea and Vietnam are ultimately what Argentina has to implement in order to narrow the productivity gap. Both Milei’s and populist recipes have fallen short in this regard.

Dollarization misses the mark: a country is better off not dollarizing in the first place if it can generate enough foreign exchange to support itself.

(Adapted from LiveMint.com)

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