The Risks of De-Dollarization in Latin America

During the 2023 BRICS (Brazil, Russia, India, China, South Africa) summit, Brazilian President Luiz Inacio Lula de Silva (Lula) asked, “Who was it that decided that the dollar was the currency after the disappearance of the gold standard?” His impassioned speech called for the adoption of an alternative currency to the dollar.

The aforementioned BRICS countries, along with several others, have been discussing de-dollarization: an alternative to the current dollar-based international trade and our present financial system. The most recent trigger for these deliberations is Western sanctions on Russia following its invasion of Ukraine. These sanctions have effectively frozen Russia’s dollar deposits and prevented many Russian banks from participating in international transactions that use the dollar. Such blanket sanctions have raised concerns in BRICS countries, notably China, that they might be subjected to similar restrictions as their relationships with the U.S. worsen. However, even before the recent push from China to de-dollarize, various Latin American governments had considered doing so for their economies. 

Most Latin American economies have traditionally had strong trade relations with the U.S.; it used to be their largest trading partner. While the U.S. dollar has been a very reliable currency due to its stability and extensive use in international trade, many Latin American economies have gone through periods of high inflation that devalued their local currencies. For example, in the 1980s, many Latin American countries such as Brazil, Argentina, Peru, and Bolivia experienced annual inflation rates of over 50 percent due to their own debt crises and economic policy mismanagement. Furthermore, dollar-based financing markets—where most corporations and governments borrow money—allow firms to more easily raise large amounts of money than their local counterparts. As a result, nations carry out financing activities based on the U.S. dollar.

While dollar-based financing is easier to obtain over time, nations have faced currency depreciation as a result of difficulties repaying their dollar debt since high inflation rates erode domestic currency value. With a weaker currency, repaying debt is much more expensive for dollar-debt borrowers. For example, in 2020, a then de-dollarized Argentina that was unable to pay back its debts defaulted on the payment of its dollar-based international sovereign bonds. This was the third time it has done so in the past two decades. Argentina had to restructure its debt with the help of the International Monetary Fund (IMF)—an international organization established to finance countries going through economic distress. Countries with debt problems can access funding from the IMF, regardless of whether their economies are dollarized. Other Latin American countries have faced similar problems over the years. In 1995, the Mexican government had to drastically devalue the Mexican peso, triggering a financial crisis.

At surface level, this makes de-dollarization seem like an attractive policy to pursue. It allows countries to regain control over their monetary policy and exchange rate mechanisms, providing them with greater flexibility to manage economic shocks and pursue economic strategies independent of the U.S. Many supporters argue that an extensive dependence on the dollar ties the local economy to American policy, such as with the Federal Reserve’s interest rate decisions. For instance, if a country’s economy is experiencing a recessionary downturn and would benefit from lower interest rates while the Federal Reserve is increasing interest rates in the U.S., the resulting dollar-based interest rates could be problematic for that country.

However, de-dollarization is not a favorable policy for Latin American nations. It does not solve the root cause of the problem: monetary policy effects such as excessive money printing that increases inflation along with undeveloped local financing markets that cannot sustain the financing needs of these economies. Unlike the 1980s, most countries no longer directly peg their currencies—fix their currency exchange rate with respect to the U.S. dollar—meaning countries do have a lot of flexibility in setting interest rates to respond to local economic conditions. However, using the dollar as their primary trade and financing currency forces policymakers to adopt policies that keep inflation contained in their economies, which is a net positive since otherwise high periods of inflation cause drastic living standard degradation.

During de-dollarization conversations, the Chinese Renminbi is often put forward as a potential alternative to the dollar, as China is now the largest trading partner for many Latin American countries, such as Brazil. Within BRICS, China is actively pushing for its trading partners to adopt the Renminbi as a trade currency, but replacing the dollar with the Renminbi just shifts these countries from using one international currency to another, creating a similar set of risks but with China in the driver’s seat instead of the U.S.

Another pitfall of de-dollarization is the potential for these economies to become investment-starved. Replacing liquid dollar-based financing markets—that countries depend on—with an equally liquid local market is a challenging task that would require consistent effort. Liquid markets depend on the development of a large, local investor base and consistent governance in order to uphold investor rights. Inability to raise the required money could put pressure on economic growth and standards of living, harming citizens of Latin American nations.

Finally, Latin American countries are large producers and exporters of commodities, which are mostly priced and traded in dollars. President-elect Trump has indicated that he would impose tariffs of up to 100 percent on imports from countries that choose to de-dollarize. Unless a market with a different currency for these goods develops, it is not practical for these countries to think about reducing their dependence on the U.S. dollar.

Recently, Argentina’s newly elected president Javier Milei has advocated for re-dollarizing the Argentine economy. His proposed plan would either make the U.S. dollar the primary currency in Argentina or make it a parallel second currency, meaning Argentine people can more easily use the dollar for banking and their daily lives. Milei entered office when the Argentine economy was suffering from hyperinflation, with prices increasing by 25 percent month after month. During his year in power, the implementation of some of his economic policies has slowed inflation to around 2.7 percent in October. The success of Milei’s economic policies so far shows that dollarization can actually be beneficial for economies suffering from inflation, among other economic problems. 

Ultimately, adopting robust economic policies that focus on increasing growth and containing inflation in a world with the dominant dollar may be a better approach than de-dollarization. Policies that promote economic growth, such as those that make it easier for businesses to invest, can strengthen local currencies. 

To answer Lula’s question, the dollar became the global standard because it offers a stable and internationally trusted currency for trade, and it provides access to markets for governments and businesses to easily fulfill their financing needs. While it is natural for countries to want more control over their national economic policies, they can already achieve these goals by managing their local currencies and interest rates. Using the dollar for international transactions and financing does not equate to relinquishing national identity—instead, the dollar system is the best mechanism to ensure that a country can effectively trade.