We are approaching the October presidential elections in Argentina, in which Javier Milei, who surprised in the PASO, presents one of the most controversial proposals. In his own words, he wants to explode the Central Bank. By this he means to dollarize the country in order to eliminate inflation, which has depreciated the Argentine currency in the last decades. While this measure has supporters and detractors, it is worth asking what happened in 2001 in Argentina after they had a fixed exchange rate policy during the 1990s.

In 1989, Carlos Menem became president of Argentina with an economy suffering from hyperinflation and in recession.. In this context, in 1991 the convertibility plan was introduced. This consisted of pegging the new currency - the Argentine peso - to the dollar, the exchange rate being 1 to 1. The government convinced investors that they would seriously manage the country's economy and committed themselves not to devalue their currency against the dollar, leaving it fixed.

Inflation is affected by expectations, so the government had to be credible in its mission to fix the exchange rate and not to devalue it. For this, they had to have sufficient dollar reserves in the Central Bank and avoid printing pesos to maintain the 1 to 1 ratio.

This, and other economic liberalization policies, such as the reduction of tariffs and taxes, and the privatization of public enterprises, among others, yielded good results in spite of the doubts: inflation was reduced to 17.5% in 1992; 7.4% in 1993; 4.2% in 1994 and close to 0% for the rest of the decade. On the other hand, the economy was growing at accelerated rates. Argentines, both companies and individuals, began to have greater access to credit, and relying on the exchange rate peg, they borrowed in dollars at a lower rate.

However, fixing one currency to another has contraindications: it implies abandoning the conduct of monetary policy, since the amount of dollars in the economy starts to depend on the balance of payments, because the Central Bank cannot print dollars. A country that cannot conduct monetary policy must be extremely responsible with its public debt, because in recessions it needs to conduct expansionary fiscal policy more intensely to compensate for the lack of changes in the TPM.

Although the economy was on the right track, in 1999 Argentina went back into recession. This occurred when the dollar appreciated against other currencies in the second half of the 1990s, and other emerging countries suffering from financial crises (Russia, Mexico, Asian countries and Brazil) were trying to get out of them by devaluing their currencies. This put pressure on Argentina and made investors nervous. Since the currency was pegged to the dollar, it also appreciated, making the peso overvalued.

This, together with the devaluation of the Brazilian currency - a country that represented an important part of Argentina's exports - reduced exports, increased the trade deficit and reduced production. With the recession, the Argentinean State began to receive lower revenues and started to run larger budget deficits. Investors began to wonder if Argentina was going to devalue its currency to cope with the decrease in production, so they began to charge more for Argentina's public debt. This made it more difficult for the Menem government to endure without devaluing.

In 2001, Argentina defaulted and then abandoned the convertibility plan. This caused the Argentine peso to soar. All individuals and companies that had taken loans in dollars suffered an increase in their debts (calculated in pesos). In addition, since banks were more exposed to the dollar, and did not have the central bank as lender of last resort due to the shortage of dollars, their debts increased. due to the dollar shortage, the amount of dollars that could be withdrawn from banks was limited so that the liquidity crisis would not turn into solvency problems. This led to protests that ended with the resignation of President De la Rúa and led to a string of presidents in a few weeks, turning into a political crisis.

If elected, Milei will have to convince Argentina and investors that his proposal is serious and responsible, so that it can obtain the desired results and thus lower the inflation that Argentines have suffered for decades.

Vincent Dourthé

Private Debt Team Fynsa AGF