Argentina: The Currency Competition That Wasn't

Despite Milei's pronouncements, currency competition in Argentina won't be very competitive after all.

When libertarian economist Javier Milei was elected to the Argentine presidency in December 2023, the world didn’t know quite what to expect. The chainsaw-wielding political novice promised a radical overhaul of the Argentine institutional order, with the aim of bringing down an inflation rate that had risen to 25% monthly. One year on, and even Milei’s critics must recognize that his policies have resulted in meaningful progress.

In November 2024, Argentina’s monthly inflation rate fell to 2.4%, its lowest level in four years. Perhaps even more impressively, Milei’s government continues to poll at nearly 50% approval, despite a sharp rise in poverty owing to strict austerity measures. In a speech last month to mark his first year in office, Milei celebrated these early successes, while also discussing additional economic measures his government plans to implement in 2025.

One of the most intriguing of these measures is the introduction of free currency competition, which will theoretically allow Argentines to use whichever currency they prefer in daily transactions. Due to the peso’s persistent inflation troubles, many Argentines already use US dollars widely, particularly for high-value purchases like real estate and luxury goods. Thus, currency competition might appear to pave the way for full dollarization of the Argentine economy, a long-standing Milei campaign promise.

But while Argentine citizens may be free to use any currency they wish, the Argentine government will not. Crucially, the payment of taxes will continue to be done in pesos. For this reason, Milei’s currency competition scheme is much less competitive than it initially appears. Argentina may have already passed peak dollarization.

Background: Why Dollarize an Economy?

‘Dollarization’ refers to the idea of replacing a nation’s domestic currency (like the Argentine peso) with the US dollar. This is not a novel concept in Latin America. Ecuador, Panama, and El Salvador have all adopted the US dollar as their national currency, including for the payment of taxes.

Dollarization effectively acts like a straitjacket on government spending. Unlike a domestic currency, a government cannot freely print dollars in order to fund expenditures (with the exception of America’s). Instead, spending is limited to the dollars that a government can borrow via bonds or raise via taxes.

This strategy is not without downsides. By sacrificing all monetary sovereignty, a dollarized government is less able to respond to economic downturns or financial crises. Moreover, borrowing in an external currency introduces the risk of sovereign default, which can make long-term government deficits risky. For governments that have lost all credibility to control inflation, however, adopting the relative stability of the US dollar offers a ‘break-the-glass’ solution.

Throughout his campaign, President Milei was vocal about his support for Argentina’s dollarization. One year on, however, and implementing that policy has proven far trickier than expected. The biggest reason why is that the Argentine government appears to have scarcely few dollars to work with. While the Central Bank of Argentina (BCRA) is coy about the exact amount of their dollar reserve holdings, estimates indicate that the bank owes upwards of $10 billion more in foreign currency liabilities than they hold in foreign currency assets.

As a result, outright dollarization by having the BCRA swap pesos for greenbacks does not appear feasible. Milei has not given up on his dollarization plan, however. Instead, the government is pursuing a policy of ‘endogenous dollarization,’ capitalizing on the substantial dollar holdings among private Argentine citizens.

Understanding Endogenous Dollarization

Although official dollar holdings may be sparse, private sector holdings are ample. Owing to the peso’s disastrous track record of inflation, it’s common for Argentines to use dollars for high-ticket purchases and for savings & investments. Despite capital controls, Argentina’s national statistics agency estimates that citizens hold some $360 billion in undeclared foreign currency, largely in dollars. In fact, a temporary tax amnesty last year has already drawn about $22 billion of this currency into the formal banking system.

Considering that the total volume of pesos outstanding (in banknotes and bank deposits) amounts to about $40 billion at current exchange rates, endogenous dollarization does appear to be feasible. And Milei’s plan to promote the strategy goes far beyond declaring free currency competition. The government has also announced plans to expand the technological and financial infrastructure necessary to support dollarization, including a dual-currency debit card and allowing banks to make more dollar loans.

On the other side of the equation, the government plans to “turn off the tap” on issuing new pesos, according to Argentina’s economy minister. By stabilizing the monetary base, Milei hopes to make it harder to access pesos for transactions, pushing people toward dollars. Despite these demand- and supply-side measures, however, the government has yet to make the key change that would truly push the Argentine economy toward dollarization: accepting dollars for tax payments.

Argentina & Peak Dollarization

While stability & inflation can certainly drive people toward & away from particular currencies, nothing is more powerful in terms of currency demand than taxation. As a thought experiment, suppose that the United States government declared that only Bitcoin would be acceptable for future federal tax payments. In addition to sparking a mad dash to buy the coin on the open market, this would also push businesses to accept payment in and individuals to demand salary in terms of Bitcoin. While the ‘Bitcoinization’ of the US economy may not be absolute, forcing citizens to settle their tax obligations in a particular currency creates a potent incentive for citizens to try and earn that currency.

This idea helps explain why Milei’s view that currency competition naturally allows citizens to “use the currency they want” is incomplete. Currency choices are not just made based on what people want, but what they need. If Milei truly wants to dollarize Argentina’s economy, accepting tax payments in dollars (either exclusively or along with pesos) is likely a necessary prerequisite. While Milei has stated that allowing taxes to be paid in a foreign currency is coming in the future, no concrete plans have been revealed.

On its own, the status quo is unlikely to lead to endogenous dollarization. Considering that official payments and most day-to-day transactions are made in pesos, using dollars has always been somewhat of a necessary evil for Argentines. Amidst stabilizing peso inflation, the data already shows a declining preference for dollars. As evidence, we can look to the convergence of Argentina’s formal and informal dollar-peso exchange rates.

Historically, there has been a significant gap between the government-determined ‘white dollar’ exchange rate and the market-determined ‘blue dollar’ exchange rate. As recently as late 2023, you could get more than twice as many pesos per dollar by working through informal currency dealers rather than the official banking system. As dollar demand has fallen relative to pesos amidst lower inflation, however, this gap has begun to shrink. In December, the blue and white rates traded at near parity for the first time in decades.

The upshot is that the Argentine economy may be as dollarized as it’s ever going to get. With peso inflation dropping, there are fewer ‘push’ reasons to use the dollar. And since dollars cannot be accepted for tax payments, a substantial ‘pull’ reason to do so is also absent. If Milei truly wants dollarization, he may need to execute it exogenously.

Conclusion: Argentina’s Future

Much of the preceding analysis rests on the government being able to continue managing inflation effectively. It’s far from clear that this is the case, however. In the short term, slashing government spending to choke off inflation has helped renew some faith in the peso. But a long-term solution is still necessary.

This isn’t merely about the risk of political blowback leading to the election of another free-spending, peso-printing government. Provocative as it may seem in the context of Argentina, if inflation falls to zero in the future, the threat of deflation could actually hang over the country. While that might seem far from the realm of possibility today, the Milei playbook of long-term fiscal surpluses, freezing of the money supply, and a bias against government spending to support the economy could certainly lead down that road.

Given that Milei has vowed to shutter Argentina’s central bank, it’s clear that the president is pinning his hopes on dollarization as the country’s long-term inflation solution. Attempting to achieve that dollarization through currency competition and endogenous adoption, however, is an incomplete and insufficient plan.