Which countries don’t have a central bank as Milei proposes in Argentina (and how this affects their economies)

Only a few countries in the world have given up having a central bank in their institutions, and almost all of them are actually micro countries: Kiribati, Tuvalu, Andorra, Marshall Islands, Isle of Man, Monaco, Nauru, Micronesia, Palau or the small Principality of Liechtenstein – in the heart of Europe – are some examples.

The only name on this list with millions of residents is Panama, which agrees with the rest in using foreign currency as legal tender. In this case the dollar.

The proposal by Javier Milei, Argentina’s president-elect who won Sunday’s elections with more than 55% of the vote, to ‘dynamize’ the Central Bank of the Republic has put the issue on the table How does a country live that does not have this organization?

The first thing a country without a central bank loses is an individual sovereign monetary policy. This means that it cannot set interest rates or exchange rates against international currencies. Can not printing money or financing the state’s public expenditure.

The institution is also responsible for overseeing commercial banks and payment methods as it is responsible for regulations that the financial system is solid and reliable. And they also have the power to manage international reserves.

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Your role is important because It affects the country’s finances and the value of the national currency.

So if a country decides to replace its national currency with a foreign currency –such as Panama with the dollar or Monaco with the euro– the main powers of a central bank are no longer meaningful.

That means one The dollarized economy will depend on the decisions The United States Federal Reserve, and one that operates with the euro, is subject to the European Central Bank.

The advantage for areas that borrow monetary policy from another currency is that eliminate exchange rate uncertainty so that they can more easily export their products to international markets.

“Because they are such small countries, International trade is very important for your economy. For them, the benefit of the absence of exchange rate uncertainty is much broader than any benefit of controlling the domestic economy through monetary policy,” said Omar Rachedi, professor at Esade’s Department of Economics, Finance and Accounting.

Essential tasks

But “even in dollarized countries, a supervisory authority is still needed, such as in Panama. There is no official central bank, but there is one a financial supervisory authority responsible for the supervision of commercial banks and macro-prudential regulation,” Eileen Gavin, analyst from Verisk Maplecroft’s finance team, told BBC Mundo.

Rachedi recalls that for an economy to continue to function, there are tasks that someone must continue to do.

“The central bank can implement it or an agency that replaces it such as the Ministry of Economic Affairs. “You can eliminate the organism, but not all the tasks,” he says.

And that is the goal of almost all central banks in the world preserving the value of the country’s currency and maintaining a low level of inflation.

Broadly speaking, it is an organization responsible for slowing down an overheated economy when there is inflation by raising interest rates, or for reactivating the economy when it is cooling by doing the exact opposite: lowering interest rates . Low rates give businesses and citizens access to credit to buy things.

It happened during the covid pandemic and The central banks of Mexico, Peru, Brazil and Chile earned international respect for his handling of rising interest rates in anticipation of the troubles to come.

They are being considered professional and independent government institutionssomething that attracts foreign investors by generating confidence and stability.

International reserves

“If a country does not have a central bank, the supervisory body that replaces it must take care of the country’s liquidity and international reserves, which is absolutely crucial in a dollarization plan because it ensures stability,” says Gavin.

“International reserves really are the last line of defense of an economy,” he says.

And Argentina’s are and have been at the limit for years. Because to protect them ‘central banks must be independent of the government, which is often the case That doesn’t happen in Latin America”, says the analyst.

“The central bank should not exist,” Milei wrote in a column for the prestigious weekly magazine The Economist.

“Over the past twenty years, the country’s politicians and their puppet masters, who profit from the status quo, have stolen billions of dollars from hard-working Argentinians through inflation. We estimate that politicians have done this in the past year alone They stole more than 5% of the country’s GDP by devaluing the peso”.

Milei argues that the central bank’s lack of independence and its willingness to do so print pesos to finance spending programs of successive governments is what has pushed up prices.

According to him, the institution is responsible for the fact that Argentina will end the year with a expected inflation of 180%.

What cost 200 pesos at the beginning of 2023 ends the year with a supermarket tag of 560 pesos.

Radical approach

“Eliminating the central bank is essential. There is no future for Argentina with the peso. “You already know what my position is in this epic battle,” Milei says in the article.

For many this is one radical approach to solve the country’s economic problems.

‘Argentina is thinking of exporting its monetary authority from Buenos Aires to Washington, instead of thinking about how reform the law to make the central bank fully independent of politics,” says Rachedi.

What is clear is that if the economy of Argentina exchanges the peso for the dollar, The functions of the Central Bank of the Republic are going to change.

“One of their tasks will obviously no longer be spending money. What Milei wants to avoid is that attitude we must continue to finance government budget deficits and spend” says Juan Carlos Martínez Lázaro, economist and professor at the IE Business School of IE University.

The teacher compares what is happening in Argentina with have a euro printing machine in the basement of the house.

“You would have no problem spending as much as you wanted without any form of control. This is what is somehow happening to the Argentine government. The central bank prints the pesos it wants and that allows you to maintain a level of expenditure that would otherwise be really complicated,” says Martínez Lázaro.

“But this only causes inflation and depreciation of weight,” he adds.

Banned in many countries

This process, Technically called “deficit generation.” In economics, it is absolutely forbidden at most central banks in the world.

“One of its most important functions, namely the issuance of money and thus control over the money supply, would largely disappear because the bank would no longer be able to issue pesos.”

“Without central bank, a country loses part of its monetary sovereigntyvery useful to face possible recessions or possible inflation crises,” says Martínez Lázaro.

Milei has proposed cutting government spending and dollarizing to halt rampant inflation.

“However, the fiscal space is limited and deep and prolonged recession to calm inflationwhich reached 142% year-on-year in October,” said Michael Langham, emerging markets analyst at Abrdn’s Global Macro Research team.

“To achieve any significant success, Argentina will need a painful recession and major reforms to improve the business environment and encourage foreign investors and domestic savers to reinvest in the country,” the analyst said.

When dollarization finally happens, that will be the biggest problem exchange rate at which the national currency is converted into dollars Americans.

“A very weak conversion rate can destroy the purchasing power of the population, but sort of Too strong a conversion can make the economy no longer competitive in the presence of their business partners,” Thierry Larose, manager of Vontobel, explains to BBC Mundo.

For this reason, analysts agree that Milei’s plan to close the central bank and dollarize will not happen in the short term and due to the size of the economy. You won’t be able to look at how other smaller countries did it.

In Latin America, Ecuador dollarized its economy in 2000 without closing its central bank. an interim solution that had its own complications because the reserves remained available for governments to continue financing themselves with those funds.

Time will tell whether Milei finally follows through with his plans and whether the Argentine economy manages to overcome all the challenges it faces. (JO)