The Emerald Country

Why do Argentinians love US dollars so much?

Jan 15, 2022

Fiebre del dólar remite en Argentina ante estabilidad del peso | Servicio Bloomberg Professional — Man looking at the screen in a currency dealer. From Bloomberg

South Americans… are always in trouble about their currency (…) the Argentines alter their currency almost as frequently as they change their presidents… No people in the world take a keener interest in currency experiments than the Argentines.
The Bankers Magazine of 1899

Argentina is the country with the second most US dollars in circulation, after the United States and over countries that actually use the US dollar as their own currency. The price of major items, from houses to cars to cellphones, is spelled out in dollars first, and USD wages are an easy shorthand for income. Why is the country like this?

I wrote a related piece in Spanish a couple of months ago, so you can read that if you’d like.

The Yellow Brick Road

Money’s a matter of functions four,
A Medium, a Measure, a Standard, a Store.
1919 couplet

To understand the dollar, we must understand it’s “rival”, the peso (and, briefly, the Austral). What is money for? In his extremely influential textbook “Principles of Macroeconomics”, Gregory Mankiw says:

Money has three functions in the economy: It is a medium of exchange, a unit of account, and a store of value. These three functions together distinguish money from other assets in the economy.

Even if this is somewhat contestable, for a number of reasons, let’s not go down that rabbit hole and instead focus on an actual question: what does store of value even mean? Traditionally, it could have been understood as money having inherent value, i.e. being made of or backed by gold. Obviously this isn’t true. Similarly, saying that money holds its value across time isn’t very helpful, because it’s evident that people only save money to spend it later - i.e. saving isn’t different from the demand for money, it’s a part of it. A very common misconception, it seems, is that money that is saved isn’t demanded, or that the demand for money does not include savings. For obvious reasons, this is wrong; the difference between transactional demand (i.e. money you keep in your wallet or bank account to pay for things) and speculative demand (i.e. “savings” or what are commonly referred to as “investments”) is when the transactions take place.

Anyways, off this sidenote, the traditional story of how money came to be is that currency replaced barter, since barter was complicated in terms of determining relative prices (i.e. how much corn was an apple worth) and double coincidence (did the apple man want corn, or not?). This is just not true at all - it actually seems that people used to just agree to owe each other money, and that currencies emerged as a way to simply quantify those debts accurately. There is also an issue of trust: as communities grew larger and more complex, there was less information available on who was creditworthy and who wasn’t. The government developed its monopoly on currency to solve all of these issues, and to keep currency in circulation and bypass the problem where a privately managed currency might not have sufficient power to keep the market operating.

The Wicked Witch

This obviously came with a number of issues attached. Starting in Antiquity and all the way through the Middle Ages and into early Modernity, the value of money depended directly on the amount of gold (or silver) each coin contained. Kings, lords, and emperors knew this, so whenever they needed extra revenue they could make all existing coins be worth less - 100 gold crowns went from having 100 units of gold to, say, 95, representing a profit. In modern, non-gold related days, the government still receives a profit from the difference between what it costs to print money and what the amount represents, since 100 dollars don’t contain a hundred dollars worth of paper. For instance, printing 100 pesos (about 4 dollars back in 2017) cost 1.50 pesos five years ago, making paying for 100 pesos worth of real world stuff with 100 new pesos possible. In fact the low cost (and low quality) of Argentinian peso bills led to them being nicknamed “crunchies” (crocantes) by the local Twitter community.

As argued here before, inflation is always and everywhere a monetary phenomenon (you can read about it, applied to Argentina and in Spanish, here - also by me!). There is, in the magical state known as equilibrium, a given number of goods, services, and jobs going around. The price of each thing is determined by how many units of currency are needed to purchase it - that is, the ratio between items and money. Milton Friedman used a famous example of a helicopter doubling the amount of money in a town: if everyone had twice as much money, when they tried to spend it, they’d simply push up prices to twice their previous level. If the economy is in a recession, or the money is not evenly distributed, then the effects might not go one-to-one (most real life examples show monetary policy can move the economy and not just prices around).

So, when the government creates money (and later spends it, duh), it is reducing the value of all other existing money - because prices have gone up. Inflation might be a monetary phenomenon, but “sustained high inflation is always and everywhere a fiscal phenomenon, in which the central bank is a monetary accomplice”, in the words of Thomas Sargent. Historically, this has been the case for Argentina - the seigniorage required to fund the fiscal deficit has moved inflation. The policy and macroeconomic implications of this aren’t especially relevant at the moment.

US, the Great and Powerful

Either way, the issue is that when actual, persistent inflation shows up, people don’t like it for a number of reasons. It seems to be more unstable, but the main issue is very clearly the instability of real purchasing power. Imagine a place with an inflation rate of 10% a month, plus minus 5%. Each month you’d expect 10% inflation, but you’d have a roughly equal chance ofbeing able to purchase 5% more or 5% less of the same items. Crucially, this doesn’t just apply to wages and prices - it applies to all nominal variables.

Composition of a portfolio in 2009. In yellow, cash USD; in green, USD deposits; in orange, peso deposits; and in pink, cash. From Burdisso & Corso (2011)

Here’s where savings and investments come in: how can you rate how profitable any given opportunity is if you only have imperfect, volatile gauges to discount inflation? You don’t. In the past (and present), the enormous uncertainty over the actual profitability of portfolio returns has resulted in financial assets being directed mainly at US dollars - and given the frequent expropriations thereof through forceful conversions into domestic currency, in US dollars in cash, “stuffed in the mattress” as is said locally - resulting in cash USD having a share of total financial assets 20 times larger than USD deposits.

Imagen — Real returns of assets in pesos (X axis) and USD (Y axis) in the 1960s and early 70s (A), 1980s (B), 1990s (C), post-2003 (D). Same source as above.

Looking at the real returns of assets, the most inflationary period, the late 70s to late 90s, included very negative returns in both currencies, whilst the zero-inflaton 1990s had stable, positive returns for both. The 1960s had widely variable returns from financial assets because of the volatile currency policies, inflation rates, and interest rates of the era; meanwhile, the early 2000s showed negative returns for both every year since 2003. Optimally, a portfolio would have been made up by 100% USD assets in multiple periods, whilst a 0% USD portfolio only in a handful of specific times, and some fraction in between for the rest of the time.

Composition of portfolios between real and financial assets, 1968 to 2010. From lightest to darkest: real estate, durable equipment, USD assets, peso assets. From Burdisso, Corso, & Katz (2013)

There is a clearly negative relationship between the demand for USD assets and the demand for peso assets as well, explained (again) by the stable-ish value of the dollar versus the wildly fluctuating real value of money. Including real assets in porfolios, (that is, real estate and machinery) we find that the same wild variation of real returns incentivized investing in durable stock, especially in the USD-denominated real estate sector.

Over the long term, this actually had a negative result in the economy. In the 1960s, James Tobin proposed that, under certain conditions, a non-zero inflation rate could be positive for economic growth, since it would discourage saving in financial assets and into real assets (that is, capital) - the Tobin Effect. Evidence for it is contentious, and the theory is highly dependent on initial assumptions. But, it’s especially clear that the assumptions that savings rates don’t change when real returns are lower, and that there’s only productive capital (absent real estate capital), have been clearly not true. This is because, since a higher inflation rate also includes more variable real incomes, people both save less and direct their savings away from nominal peso contracts and towards USD-valued opportunities. Consequently, the total stock of capital was persistently smaller than optimal across the 20th century due to monetary instability - a perverse Tobin Effect. This is in tune with evidence supporting the claim that monetary policy, and its consequences on the inflation rate, have not had neutral effects in Argentinian history.

Conclusion

What’s the takeaway? That inflation has been really bad for Argentina, for sure. Irresponsible fiscal and monetary policies, dictated by rotten institutions, have had enormous effects on the inflation rate. This, in turn, moved savers away from economic decisions that would have improved the country’s fortunes through higher investment, output, and employment, and towards defensive stances designed to protect their (scarce) incomes from inflation. A shaky legal system and poor financial institutions only added to these troubles, since people also shielded themselves through legal expropriation by starving out the financial system.

Over the long term, then, the “original sin” of bad policy reverberated on every other aspect of the economy, since it being paired with exiguous interest rates and sky-high price growth resulted in negative outcomes, not only for individual savers, but for the country at large. Resolving inflation, and weaning the Treasury off the money printers, would not only improve real incomes and stabilize the economy, but would also channel savings into the local currency, and increase productive investment.