Is the dollar the right answer for the region?
During his campaign, Argentine President Javier Milei promised to close the country’s central bank and adopt the dollar as the country’s currency. Once elected, he changed his strategy. The natural dollarization approach involves restrictions on the supply of pesos, forcing Argentines to use their dollar reserves to pay for everyday expenses.
With the peso stabilized, inflation reached 117% in December 2024, down from 292% from the year’s high in April, and the use of the dollar is expected to increase, including for day-to-day transactions. “Argentina is now counting with two official currencies, and Milei is counting on people’s savings in dollars to increase the American currency in a local economy,” says José Leoni, managing director of corporate consultancy Moneyminds Partners.
According to Leoni, dollarization should be a temporary solution, as the main economic problems are not solved by controlling only the currency emissions. The government accounts are in dollars, and insufficient savings exist to pay these debts. “It might not provide enough resources for the economy, and this measure doesn’t solve all the issues,” says Leoni.
According to Fábio Giambiagi, a researcher at the Brazilian Institute of Economics, a unit of the Getulio Vargas Foundation, there is no proper way to implement dollarization. “Argentina does not have the reserves to make this transition; and without dollars, there is no dollarization,” he adds. “Counting on personal savings for a government measure is not currency replacement.”
Eduardo Borensztein and Andrew Berg, the authors of “Full Dollarization: The Pros and Cons,” published in 2000 by the International Monetary Fund (IMF), examine potential advantages and disadvantages of full dollarization from the perspective of any hard-currency country. They reveal that dollarization may appear more radical than it is: the use of the US dollar or another major currency is pervasive to some degree in most developing countries, particularly in financial contracts.
“The main attraction of full dollarization is the elimination of the risk of a sudden, sharp devaluation of the country’s exchange rate,” the IMF writers point out. “This may allow the country to reduce the risk premium attached to its international borrowing. Dollarized economies could enjoy a higher level of confidence among international investors, lower interest rate spreads on their international borrowing, reduced fiscal costs, and more investment and growth.”
Latin American Experience
This is hardly new. Panama was the first country in Latin America to adopt the US dollar, in 1904, shortly after independence from Colombia. Almost a century later, Ecuador and El Salvador followed suit, with Ecuador switching in 2000 and El Salvador in 2001. But are they taking the proper steps to control their economies?
According to Brazilian economist Otaviano Canuto, a former vice president of the World Bank and senior fellow at the Policy Center for the New South, it makes sense for some of the smaller economies in Latin America, such as Panama, El Salvador, and Ecuador, to use dollars officially to keep the economy under control. “Panama’s economy does lots of transactions in dollars on its canal, with container ports and flagship registry,” he says, describing this as a natural path.
Dollarization can make imports cheaper and exports more expensive, depending on the price relationship with other currencies. Thus, the prices of imported goods tend to be more stable, but local goods and services may increase, especially if domestic demand rises.
Since Panama’s 1904 adoption of the US dollar, the country’s local currency, the balboa, has circulated side by side with the dollar. This was intended to maintain economic stability and open the economy to trade.
Ecuador experienced a significant reduction in inflation and volatility after dollarization in 2000. World Bank data indicates that inflation reached 96.1% in 2000, then decreased to an average of 2.6% from 2004-2007. However, the country still faces challenges related to its dependence on remittances and commodity exports. “The country controls its inflation and counts on foreign currency reserves, so inflation was controlled. Oil production also helped stability,” says Canuto.
However, there are pros and cons. The World Bank says the authors of its 2024 report, Ecuador: Growing Resilient for a Better Future, “found that key structural barriers to growth include widespread market intervention, a lack of competition, limited trade integration and rigid labor regulation. The country also may face sectoral constraints that prevent it from exploiting opportunities in sectors where it already has comparative advantages, such as sustainable mining, agriculture, and tourism.”
In El Salvador, employing two currencies—the colón and the dollar—makes sense since a large expatriate population lives in the US, and dollars circulate in the economy regularly. Inflation wasn’t high in 2001, about 3.75%, but personal remittances accounted for 15.7% of GDP. After dollarization, this rate increased to 21.8% by 2006 and was 24.1% in 2023, according to World Bank data. However, the country still faces economic challenges, such as low productivity and dependence on remittances, that can impact price dynamics.
Pros And Cons
Emilio Ocampo was an economic adviser to Milei during the 2023 presidential campaign and the designer of a dollarization blueprint for Argentina. Ocampo is also a professor of finance at Buenos Aires’ University of CEMA. He explains that the most important factor is which currency the people in that particular country prefer to use. “In the case of Argentina, the preference is clearly for the US dollar despite not having legal tender status,” he notes. “It is difficult to force people to accept a currency they don’t want to use, like in El Salvador [where the government] tried to impose bitcoin and it backfired.”
He also adds that countries with a history of persistent, high, and volatile inflation and a population willing to adopt the dollar are prime candidates for dollarization.
“If a country adopts the dollar as legal tender, it should eliminate the central bank. Otherwise, the likelihood that an unscrupulous politician will try to use it in the future is high, particularly in countries addicted to populism,” Ocampo explains. “We saw how [former Ecuadorian President Rafael Correa] used the central bank to finance a portion of his excess spending. The damage he did was enormous. Ecuador is still dealing with the legacy of Correa’s policies.”
Ocampo supports the entire region adopting the dollar. “It would make sense for Latin America to dollarize and integrate further with the US economy. Greater integration in the Americas would create the most powerful economic bloc in the world.”
However, the US would have to move away from protectionism. “Brazil is unlikely to give up its currency. But if Argentina adopted the dollar as legal tender, there would be momentum for other countries in the region to follow,” he suggests.
Dollarization is an economic reform with a strong political component. On the one hand, it limits the government’s maneuvering room by preventing it from printing banknotes to finance fiscal spending. On the other hand, dollarization makes the country’s government dependent on the decisions made by the US regarding monetary policy. In fact, by adopting the dollar, countries lose the ability to implement independent monetary policies.
Although inflation may be controlled, dollarized countries must effectively manage their fiscal policies. Inflationary pressures may arise if a healthy fiscal balance is not maintained.
