Photograph of Argentine peso bills with a 100 US dollar bill. The replacement of the local currency with the dollar as a payment method or pricing instrument has been a practice that several Latin American countries have resorted to with disparate results. EFE/ Juan Ignacio Roncoroni

Dollarization debate in Latin American economies

America Desk, Sept. 19 (EFE) – Argentina’s far-right candidate Javier Milei’s proposal to dollarize Argentina has once again brought the dollarization debate to Latin America.

Countries like Panama, El Salvador, and Ecuador have adopted the US currency for years, and others like Cuba and Venezuela have solid underground markets.

In Argentina, Milei, the candidate of La Libertad Avanza, took first place (29.86%) in the primaries on August 13 under the banner of dollarization, eliminating the central bank and taking a “chainsaw” to public spending,

(FILE) Photograph dated February 7, 2022 that shows signs with price indicators in dollars of a commercial premises, in Caracas (Venezuela). EFE/ Miguel Gutiérrez /ARCHIVO

However, despite triple-digit inflation, macroeconomists speak of “insurmountable obstacles” because Argentina lacks the necessary dollars to save the monetary base and support bank deposits.

Moreover, the proposals involve “absurd increases” in public debt for a country whose securities are quoted at 30% of parity.

Dollarized Countries

The first dollarized country in Latin America was Panama, where the use of the dollar dates back to 1904, one year after it gained independence from Colombia as a result of the construction of the Panama Canal by the US.

However, the currency had already been in circulation for almost half a century thanks to the influx of travelers due to the so-called “gold rush.”

According to the National Center for Competitiveness (CNC), a non-profit public-private organization, the measure had its advantages because it allowed “one of the lowest inflation rates in the region and a competitive supply of credit.

It also favored commercial stimulation and a stable economy without a central bank or a state that could intervene in the price of money.

The CNC claims that the downside is it limits the possibility of stimulating exports through devaluations. However, “the benefits far outweigh the costs,” according to the organization.

Dollars and Balboas coexist strangely: it is known that the national currency is equal to one dollar, but it is only seen in one-unit coins with a limited monetary supply.

Panama was followed by Ecuador almost a century later, when it adopted the dollar as its sole legal currency in 2000, abandoning the heavily devalued sucre after an unexpected and traumatic decision taken by then-president Jamil Mahuad (1998-2000) as a way out of an economic crisis.

The dollar allowed the Ecuadorian economy to achieve monetary and financial stability, going from an average annual inflation of 36.4% in 1980-1998 to 4.5% in 2001-2019, according to data from the Central Bank of Ecuador (BCE).

“When politicians cannot adequately manage the currency, citizens begin to de facto dollarize the country, especially in countries with weak institutions,” says Ecuadorian economist Alberto Acosta-Burneo.

“Politicians monetize the deficit. They aggressively print banknotes to finance fiscal imbalances. At the end of the day, they pass the bill to the citizens through the inflation tax,” he adds.

However, according to him, Ecuador needs to go one step further and abolish the central bank to prevent it from issuing money by expanding its fiscal balances through placing bonds, an accounting arrangement that can create a liquidity crisis.

(FILE) Archive photograph from January 10, 2001 of the demonstration that hundreds of people carried out in La Libertad, El Salvador against the law of “dollarization” that came into force on January 1, 2001. ACAN-EFE/EL DIARIO DE HOY/ Ernesto Rivas

Dollars are also legal in El Salvador, along with the colón, since January 1, 2001, whose exchange rate was set at 8.75 units to the dollar until it disappeared when the banking system converted all accounts into dollars, and the Salvadoran colon was withdrawn.

According to economist Ricardo Castañeda, dollarization “was undoubtedly a political measure rather than an economic one, since there were no technical elements to support the decision.”

However, for El Salvador and Honduras, the “greatest advantage” of dollarization “after such a long time” is that it has allowed inflation to be “not so high,” but “it has been a brake on the country’s economic growth because there are fewer tools to influence the economy,” he adds.

Forced alternative

In Cuba, dollars are increasingly flowing into the informal market, which is more diverse and extensive than the official market, and into the formal market, where the state collects foreign currency from tourism and special shops.

The government’s measures to combat this have proved ineffective.

High inflation, forced imports (80% of what Cuba consumes, according to the UN), the devaluation of the Cuban peso (from 24 pesos to the dollar in 2021 to 240 at present), and the emigration of hundreds of thousands of Cubans are some of the reasons for the popularity of the US currency.

(FILE) Photograph of signs with price indicators and payment methods of a commercial premises, on February 7, 2022, in Caracas (Venezuela). EFE/ Miguel Gutiérrez

Similar reasons affect Venezuela, where the dollar has been used to pay and set prices since 2019 when the country went through hyperinflation that closed 2018 at 130,060%, adding to an electricity crisis that, on several occasions, collapsed the electronic means of payment in bolivars.

The unofficial dollarization, which the government sees as an escape valve, has “facilitated transactions, commercial operations,” and the emergence of services such as home deliveries and taxis. However, it is not yet allowed to open bank accounts to make transfers or ask for loans in dollars, Ecoanalítica’s senior economist, Jesús Palacios, told EFE.

However, the Venezuelan government has taken measures, such as a tax on payments in foreign currency, to keep dollarization under control and encourage transactions in bolivars, which will reduce the number of transactions in US dollars by almost 70% in 2021 to 50% in 2023.

Parallel currencies

In Peru, the dollar has coexisted with the sol for decades: you can buy foreign currency in any bureau de change, purchase real estate in dollars, or open bank accounts, time deposits, or loans.

The Central Bank of Peru (BCRP) has carried out spot sales operations (at the day’s exchange rate) on negotiation tables for one million dollars. It has auctioned sales of currency swaps and BCRP CDRs (Certificates of Redeemable Deposits).

The same happens in Uruguay, where the peso remains the official currency most used for daily transactions. However, some prices in shop windows – especially for appliances, vehicles, or real estate – are quoted in dollars.

(FILE) Photograph dated April 26, 2023 showing a notice with the price of various currencies in a store in Buenos Aires, Argentina. EFE/ Juan Ignacio Roncoroni /ARCHIVO

The dollar has also monopolized deposits, and Uruguay has the highest level of deposit dollarization in Latin America at 74%, according to Moody’s.

In neighboring Paraguay, the guaraní is the official currency. Still, the dollar is the reference currency for international transactions, and its free sale is allowed in official houses and banks.

Economist Jorge Garicoche explains to EFE that deposits in Paraguay’s financial and banking system show a ratio of about 60% in guaranís and 40% in dollars, despite a global trend of depreciation of the local currency promoted by the Federal Reserve (Fed) to curb inflation in the United States.

Although economists like Acosta-Burneo do not believe that the entire region will end up dollarized, he sees a possible coexistence with local currencies if the example of Peru is followed, which “has had an excellent management of the currency (sol), with a fairly solid and independent central bank.” EFE