Dollarization Is Not Magic

In a recent New York Times article, Paul Krugman dismisses the idea that dollarization might improve Argentina’s economy. He describes dollarization as a magical solution. In doing so, Krugman commits the strawman fallacy. He overlooks the constraints and institutional anomie that alternative monetary reforms face in Argentina.

Argentina currently grapples with one of the world’s highest inflation rates. With the latest inflation rate reaching a staggering 160 percent, it is dangerously close to hyperinflation. The core issue driving this economic turmoil is the absence of institutional constraints and credible commitment devices in the country’s monetary policy. The lack of effective constraints allowed the Kirchner administration to print too much money, as has come to be expected in Argentina. Inflation has averaged 60 percent per year since the mid-1940s.

Dollarization isn’t a fantastical solution, as Krugman claims. It has actually worked in the real world. Facing the specter of hyperinflation, Ecuador embraced dollarization in 2000. Its economy stabilized. Average incomes rose, the poverty rate fell, and the country’s income distribution improved. Zimbabwe similarly turned to dollarization in 2009 to quell rampant hyperinflation. These cases underscore the practicality of dollarization in addressing the kind of out-of-control inflation that has persisted in Argentina.

Krugman fails to identify a single dollarization advocate who asserts it to be a magical remedy.  The alleged magic seems to be a product of his imagination. Contrary to what Krugman would have one believe, advocates of dollarization don’t claim it is a cure-all solution. It is, in their view,  a pragmatic second-best approach to rein in extraordinarily high rates of inflation. Many reputable economists have supported dollarization in extraordinary circumstances. It is not a crazy idea.

Krugman also fails to propose a realistic and durable alternative for Argentina’s economic challenges. Argentina has already tried the alternatives. A heterodox currency board in the 1990s ended in one of its largest economic crises in 2001. This failure opened the door to more than a decade of left-leaning populism under Nestor and Cristina Fernández de Kirchner. In late 2016, Argentina formally implemented an inflation-targeting regime. Its central bank was managed by a dream team of Ivy League economists. It didn’t work. Twenty-five months after implementation, Argentina experienced a currency crisis. 

The time for half measures is over. Argentina needs a durable and credible solution to its chronic inflation. Since dollarization is robust to political interference by current and future governments, it is more likely to work and more likely to last. Dollarization is no panacea. But it has proven successful in mitigating hyperinflation in real-world cases. Rather than dismissing it as magic, one should recognize that dollarization is a pragmatic approach to restoring stability in high-inflation countries that lack credible institutions. If anyone is succumbing to magical thinking, it may well be Krugman. He overlooks the practical benefits of dollarization in the face of potential hyperinflation and offers no realistic and durable alternatives.

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