Demystifying the economy | Why adopt the American dollar?

Every week, you send your questions on the economy, finances, markets, etc. Our journalists try to answer them with the help of experts.

Argentina could adopt the US dollar and eliminate its central bank. Could this save its economy? asks Marc Lamarre, from Stukely-Sud. Can a state survive without a central bank? Who will ensure monetary policy? Who will lend money to banks? asks Amélie Godin for her part.

The coming to power in Argentina of a president with radical ideas such as abandoning the local currency, the peso, and closing the country’s central bank raises many questions. To answer this, we asked for help from Desjardins senior economist Hendrix Vachon. “Adopting the US dollar as a national currency is a way to regain financial stability,” he explains. And Argentina really needs stability: the economy is exhausted, its national currency is no longer worth anything and the inflation rate exceeds 100%.

Countries that have already chosen to swap their currencies for the dollar, such as Ecuador and El Salvador, have regained some financial stability and inflation has calmed. But this is not a miracle solution, underlines the economist. It cannot solve all the problems of a country and above all, it comes with a price. The country which renounces its national currency also renounces its monetary policy which becomes that of the United States, if it adopts the American currency. This is a major sacrifice, because monetary policy is an important intervention tool for a country. It allows a State to intervene in the economy to stimulate growth or mitigate the impacts of a crisis.

If the U.S. economy overheats and interest rates rise to cool things down, Argentina will have to live with high interest rates even as its economy weakens. When a crisis breaks out in the world, the US dollar appreciates because it is considered a safe haven. For a country like Argentina, the appreciation of the dollar could mean a drop in its exports which have become more expensive for buyers.

A country that renounces its currency also renounces its central bank, which no longer serves any purpose. The main functions of Argentina’s central bank, issuing currencies and controlling interest rates, would fall to the U.S. Federal Reserve.

The country could therefore live without a central bank, but it would undoubtedly still need an entity to regulate the operation of local banks, believes the Desjardins economist. “This role can fall to the government,” he said, “which also happens to be the lender of last resort for local banks.”

Countries that decide to adopt another country’s currency do not have to ask their permission. It is towards the American dollar that countries most often turn in search of financial stability, because it is a stable currency recognized throughout the world. But a country can adopt the currency of its choice, says Hendrix Vachon, who recalls that Iceland juggled with the possibility of abandoning its crown and adopting the Canadian dollar after the financial crisis of 2008.