What Dollarization Says About Returning to the Gold Standard

Everyone’s heard of Javier Milei, the new president of Argentina, called by Fox News the world’s first libertarian president. He has been in the news for his denunciation of leftism, Marxism, and the sprawling bureaucracy that has trapped Argentina in debt. He’s also taken aim at run-away inflation in Argentina. Inflation in the last year was over 200% in Argentina, a rate that the United States hasn’t reached, even with Biden-levels of inflation.

But what might surprise some, given Milei’s libertarian leanings, is that he promised to get his country to use the American dollar. Why and what does it say about the future of fiat currency?

The use of the American dollar by foreign countries in place of their own is called currency substitution or dollarization. There are different reasons why a country might want to abandon its sovereign currency for the currency of the United States. Some of the countries that use the American dollar are small island nations or territories like the Virgin Islands, Turks and Caicos Islands, or Micronesia. These islands depend heavily on American tourists or American military spending to keep their economies afloat. The use of the dollar is a way to appeal to their most important economic partners as well as a way to reduce transaction costs and make transactions more convenient. But Argentina is a major country, it trades with America of course, but its economy is larger and more diverse than those island states.

Argentina, or at least Milei and his supporters, want to switch to the dollar because Argentina’s currency, the Argentinian peso, has been run into the ground by constant government overspending and essentially printing money to cover the costs of government programs that are oversized relative to Argentina’s economy.  According to Stephen Matteo Miller of the Mercatus Center, Argentina has already experienced unofficial dollarization, with individual citizens of Argentina holding onto dollars or dollar-denominated assets because while the American dollar is constantly devalued by inflation it is devalued at a slower rate than the peso. Thus, dollarization would make official what rational Argentinians are already doing.

Milei has run into some setbacks with the dollarization part of the agenda and he is now claiming it’s part of a long-term agenda that will follow dramatic cuts to government spending. If Argentina dollarizes, in theory, it would benefit from “only” having to deal with American-level inflation instead of Argentina-level inflation. It would also help keep government spending under control- Argentina would not be able to run huge deficits and offset its spending by printing more dollars, only the United States can produce dollars. The strength of the currency that Argentinians use wouldn’t be undermined by Argentinian fiscal irresponsibility.

What about the situation for ordinary Americans? The Biden administration, even more so than typical politicians, has gone on a relentless spending spree, taking the federal debt to new heights and unsurprisingly we have seen high inflation to go along with it. The higher the debt, the more likely it is that the government will print money to pay it off. This fear causes inflation to rise, even before the government actually does it.

Argentina can turn to the United States for a source of a more stable and reliable fiat currency. But for the United States, there is nowhere to turn. There is no larger economy. The problems that the United States faces with its fiat currency are shared around the world. Fiat currency is constantly devalued and the existence of fiat currency makes government overspending easy. Another fiat currency will never save the United States from dangerous levels of inflation.

What could? Maybe gold. Gold can’t be printed by the government. A nation on the gold standard couldn’t spend without limit- its ability to repay debts would be limited by its store of gold and what investors thought of its long-run sustainability. A switch to hard money could be a solution to American inflation. Would it have to be gold?

In theory, gold isn’t unique. Some other assets or commodities could back a currency. But in practice, only gold (and maybe silver), have the historic, cultural role of serving as money and scarcity, fungibility, and other useful traits to serve as a currency.

Will the United States return to precious metals? Maybe. But if it does it probably won’t do so instantaneously. Instead, it would follow the path of Argentina. The unofficial use of gold and silver as money and as a store of value would spike first, far before any official adoption. A fact worth keeping in mind when considering investment options.