Argentina's Milei is taking a chainsaw to the peso - is dollarisation on the horizon?

Far-right Argentinian government has allowed the currency to plunge more than 50 per cent

Javier Milei brandishes a chainsaw during a campaign rally in La Plata, Argentina, in September. AP

While on the campaign trail, Argentina's new President Javier Milei became known for carting around a chainsaw, which he would routinely rev up to demonstrate plans to cut government spending. He appears to be holding true to that promise.

The far-right Argentinian government headed by Mr Milei – a libertarian economist famous for his unruly hair and flamboyant, irreverent personality – allowed the peso to plunge more than 50 per cent on Wednesday, part of a larger package of wide-ranging spending cuts aimed at curbing astronomical rates of inflation, which now sits at about 160 per cent.

The president is looking to cut about $20 billion in public spending, equivalent to about 5 per cent of Argentina's gross domestic product.

Before the devaluation took effect, on the official market there were about 366 pesos to the US dollar. As of writing, there are now about 800 pesos to the dollar.

Economy Minister Luis Caputo announced the planned cuts to spending and the devaluation of the currency earlier this week, alongside a halt on new public works, the sacking of civil servants who have worked less than a year, the reduction of energy and transport subsidies, and a sharp decrease in federal funds being transferred to the provinces, according to El Pais.

“For a few months, we’re going to be worse than before,” Mr Caputo said.

The International Monetary Fund, to which Argentina, as its biggest debtor, owes tens of billions of dollars, welcomed Mr Caputo's announcement.

“These bold initial actions aim to significantly improve public finances in a manner that protects the most vulnerable in society and [to] strengthen the foreign exchange regime.” the IMF said in a statement.

“Their decisive implementation will help stabilise the economy and set the basis for more sustainable and private-sector led growth.”

Will Argentina dollarise?

Following the devaluation of the peso, questions are swirling over whether the new government will drop the currency entirely and adopt the US dollar.

Over the past several decades, Argentina has routinely printed new money to compensate for government overspending.

In a debate with an opposition candidate before his election, Mr Milei stated emphatically: “We are going to dollarise the country, we are going to close the central bank, we're going to end the cancer of inflation.”

But the viability of such a scheme is debatable. The country reportedly does not have enough dollars to make the change, with The Economist calculating that Argentina would need about $40 billion.

The country's net foreign reserves are estimated to be at negative $6.5 billion to as low as negative $10 billion, according to Bloomberg.

“They don't have enough dollars to convert the monetary base so they would have to issue external debt just to start to dollarise,” Elijah Oliveros-Rosen, chief economist for emerging markets at S&P Global Ratings, told Reuters last month.

“Dollarisation would not cure the main issue in Argentina, which is a really large fiscal problem.”

Unable to issue dollars, Argentina would need to take out new loans, generating even more debt.

In addition, Argentina would lose its independent monetary policy, as countries that adopt the greenback cannot adjust interest rates to regulate the supply of money in response to changing economic conditions, as that is controlled by the US Federal Reserve.

Argentina’s economy is expected to contract by 3 per cent this year, while the Fed is maintaining a tight monetary policy to fight inflation.

Some experts, however, believe that is exactly what Argentina needs and that the change would be made possible due to the habits of regular Argentines.

Though polls show the majority are reticent to dollarise, Argentines have historically had little confidence in their own currency, converting pesos to dollars as quickly as possible.

The popular phrase “colchon bank” – or stuffing dollars under the mattress – is indicative of how low trust in local financial institutions has sunk.

“At the end of 2022, Argentines held over $246 billion in foreign bank accounts, safe deposit boxes and mostly undeclared cash, according to Argentina’s National Institute of Statistics and Census,” an article published by the Cato Institute, a libertarian think tank, stated.

“This amounts to over 50 per cent of Argentina’s GDP in current dollars for 2021 ($487 billion). Hence, the dollar scarcity pertains only to the Argentine state.”

In addition, proponents of the idea point to how dollarisation, despite initial high levels of debt, significantly curbed inflation in other countries.

“First, in a dollarised economy, deficits must be financed by borrowing rather than printing money,” said Steven B Kamin, senior fellow at the American Enterprise Institute think tank.

“This borrowing may lead to higher debt and possible default, as occurred in Ecuador, but it does not trigger high inflation and its resultant distortions and dislocations of the economy.

“And once the default has occurred and the country is cut off from borrowing, as is largely the case in Argentina at present, the pressure to cut the budget becomes even stronger.”

He added that while Mr Milei's push for dollarisation is likely to be unsuccessful – he lacks support for the move in the congress and the country is too broke to buy out the existing stock of pesos – it could be a step in the “thousand-mile journey to economic stability”.