A few months of hotter-than-expected inflation numbers have led to a renewed debate around how entrenched inflation has become. Most recently, the February Consumer Price Index increased 0.4% (4.8% annualized), driven primarily by shelter and gasoline which accounted for 60% of the overall increase in price level. Energy increased by a massive 2.3% in February alone. Despite these scary numbers, inflation is still trending in the right direction. This article will show that the elevated components of inflation—shelter and energy—do not accurately portray economic conditions.

In a free market-based economy such as the US, a central bank should do as little as possible since most economic fluctuations revert to trend through stronger and more informed market forces. When a (well-intentioned) central bank responds to incorrect price signals, it risks causing further damage by unnecessarily crushing credit markets and dampening real activity. The Fed rushing to respond to February’s elevated inflation would be an example of such a mistake.

Figure 1 shows two measures of CPI inflation—owners’ equivalent rent (OER) and the aggregate index less shelter since 2010. Both inflation metrics are computed by calculating the percent change of their respective quarterly price indices and then annualized (multiplied by 4). The aggregate metric was high post-pandemic but eventually started to fall in late 2022. Aggregate inflation less shelter maintained this downward trend and remained below 2% through most of 2023. The graph shows—especially since the pandemic—that shelter inflation as measured through the OER significantly trails the rest of the CPI. (In economist speak, it is a lagged measure.) OER inflation hit its peak 2 quarters after other price measures and similarly lagged in its recovery back towards trend.

Rather than indicating that inflation is entrenched, this increase in the OER is an indicator that shelter prices increased some time back. The problem is that those price increases are just now showing up in the CPI.

Figure 1 also shows median consumer one-year ahead inflation expectations as collected by the Michigan Survey of Consumers. Keeping expectations anchored is a vital component of managing inflation and this metric too is trending down since its post-pandemic high. It is important to note that median expectations are slow to adjust and typically do not fluctuate drastically, as the graph shows. The series trended gently upward during the worst of the inflationary episode, and it is likewise gently trending down. Again, this does not indicate that high inflation is entrenched. Instead, it offers further evidence that long-term inflation is headed in the right direction.

When can shelter prices be expected to catch up with the rest of the economy’s prices? Figure 2 shows the cross-correlations between the two CPI inflation metrics from Figure 1. Cross-correlations measure the similarity between any time series and a lagged version of another time series. Plotting the cross-correlation between these series at a variety of lags, as done in Figure 2, allows a researcher to determine the lag length at which the two series are most similar. The figure shows that CPI OER inflation is most similar to the aggregate of all other CPI components at a lag of 3 to 5 quarters. This suggests that consumers will likely have to wait 9 to 15 months to see rent prices follow the rest of the economy and revert to trend. (It is also important to note from Figure 1 that OER inflation trend is higher than the other metrics; it is reasonable to expect rent inflation to fall but not to the level of other price inflation metrics.)

Reporting on inflation has also expressed concern over its other elevated component—energy. Figure 3 compares CPI energy inflation and core (i.e., less food and energy) CPI inflation since 2010. Both metrics are computed like the inflation metrics from Figure 1.

As the chart shows, inflation volatility in the energy sector is significantly higher than the core CPI. Values for energy inflation range from ‑52% to +45% in this period. Core CPI inflation only fluctuates between ‑2% to +7%. Since 2010, the standard deviation of energy CPI inflation is 18.49% while core CPI is only 1.64%; as such, energy price inflation is over 11 times as volatile as the core CPI. Like rent inflation, energy inflation does not accurately reflect any truths about the current and future path of inflation—it is simply too volatile and acts in a very different manner to core CPI. It should not be used to express concern about elevated price levels.

To be clear, it is useful and informative to have reporting on a variety of inflation metrics. The concern is if policymakers base their decisions on improper price metrics. If the Fed were to intervene and discretionarily react to short-term price fluctuations that stem from rents or energy, it would only exacerbate current economic problems. For example, an improper rate increase could further tighten credit markets, increasing default rates on mortgages or credit card debt that are already very high. Sound policymaking accounts for such distinctions. Despite the hotter than expected inflation numbers, the conclusion to be drawn remains that aggregate inflation continues to trend down.

President Joe Biden will reportedly use his State of the Union (SOTU) speech to blame corporations for high grocery bills.

The public remains deeply angry at the prices they pay for food shopping. A majority of those voters concerned about inflation cite “the cost of food and groceries” as the source of their angst.

Between January 2010 and January 2021, the price index for food consumed at home increased by less than 18 percent in 11 years. Since Biden became President, it has increased by 21 percent in just three years.

This mainly reflects the impact of high inflation, of course, much of which was baked in due to monetary excess and one-off supply-shocks from 2020 through 2022. As supply conditions have improved food prices overall are no longer going up as quickly as inflation in general. But visits to the grocery store are still a reminder of the sharp, enduring food price spikes we experienced in 2022 and early 2023.

This remains a big political problem for Biden in an election year. His administration is thus doubling down on blaming high food prices on greedy companies rather than failures of macroeconomic policy. And why wouldn’t it? The media have spent two years boosting quack corporate greed theories of inflation and downplaying the role of monetary policy. This narrative risks becoming the legacy of this whole episode: much of the public thinks corporate profit-seeking has been in some way or a great deal responsible for the inflation we’ve experienced, with few attributing blame to the actions of the Federal Reserve.

Of course, this lends itself to a range of terrible policy ideas. Rather than monetary restraint, the supposed answer is price controls and regulations on companies’ pricing structures. It’s reported Biden may even use his SOTU platform to endorse legislation put forward by Sen. Bob Casey (D‑PA), Sen. Elizabeth Warren (D‑MA), and others. All these proposed laws are either economically incoherent or based on highly misleading data.

Shrinkflation

Before the Super Bowl, President Biden complained about shrinkflation—the practice of firms reducing product or portion sizes while keeping package prices the same, thus raising the per unit price of the food, drink, or product.

Have you noticed in the past couple of years how the amount of cereal or chips in a packet have fallen? Biden thinks this is a nefarious plot to rip off customers. Senator Casey has even advocated legislation that would empower the Federal Trade Commission (FTC) to promulgate rules treating this as an “unfair or deceptive act or practice.”

Shrinkflation did happen across a range of food products, particularly in 2022. But this itself is just a manifestation *of* inflation, which ultimately had macroeconomic roots (too much money chasing too few goods).

The Bureau of Labor Statistics, which calculates the Consumer Price Index, already tries to account for inflation that manifests as shrinkflation. Their analysis shows that about 10 percent of the increase in unit prices for snacks occurred through reduced package size, with the same phenomenon, though less significant in scale, for candy and chewing gum, coffee, and ice cream. It may be the case that the basket of goods the CPI examines doesn’t capture every case of inflation, which means it’s plausible that by under-accounting for shrinking packages, the official CPI still understates the inflation consumers have faced.

The point is that in an inflationary environment, firms must decide whether to raise their headline prices or trim product sizes. Remember, inflation, ultimately, is a rise in all prices across the economy, including firms’ costs. This doesn’t mean all prices will rise by the same amount (supply and demand shifts mean relative prices between goods change too). Nor will inflation affect all prices at the same time—for some firms, costs rose first, and for others their product prices.

But, in time, inflation raises all prices, so just eating losses as your costs go up because of inflation is not an option for companies. As economist Dean Baker told Politico, “Costs have gone up — wages are 20 percent higher than they were in 2019. We’re not going to have a world where people get to keep their 20 percent pay increases and pay what they did four years ago for food.”

The logical implication is that in the absence of shrinking the amount of product within a package, firms would have raised package prices even higher than they did. Banning “shrinkflation” is effectively a mandate to raise package prices, rather than pursuing a size-price bundle that some (particularly low-income) consumers might prefer. It would also encourage gaming, with firms no doubt launching new package sizes that they sell concurrently with existing sizes, before discontinuing the latter, leading to costly legal disputes.

Biden attacking shrinkflation is thus all about anti-corporate vibes—the idea that businesses are screwing you over by squeezing product sizes underhandedly. To the extent he really believes this to be true, however, Biden should probably be grateful to firms that opted to shrink their product sizes. The alternative was higher package prices, which would have made deeply unpopular food price inflation even more salient.

Greedflation

The context for this anti-business sentiment has been a relentless propagation of “greedflation” theories from Democratic politicians and some economists. These take many forms, but the most popular tale says that firms exploited customers’ knowledge of major business cost shocks from the pandemic and Ukraine war to raise prices by more than was justified by those rising costs. Hence, businesses caused inflation.

The evidence? Greedflation theorists typically use a basic accounting identity to suggest that:

A change in unit prices (inflation) = A change in worker compensation (unit labor cost) + A change in unit profits + A change in unit costs of other inputs.

They then look at various periods and if unit prices have gone up at the same time as unit profits for companies, they conclude that higher prices are being driven by higher profits. The Economic Policy Institute (EPI), for example, produced a report claiming that, between Q2 2020 and Q3 2021, 54 percent of price increases were driven by fatter profit margins. Using the same methodology, Groundwork revived this analysis recently by looking at what happened during Q2 and Q3 of 2023, concluding that “corporate profits drove 53 percent of inflation during the second and third quarters of 2023 and more than one-third since the start of the pandemic.”

Those periods are cherry-picked because other periods tell a different story. Chris Conlon, an economist at NYU Stern School of Business, points out that, through the year Q3 2022 to Q3 2023, under this same logic, profit accounted for minus 22 percent of price increases (markups were falling) while labor costs more than accounted for inflation (increasing it 128 percent).

Was the greedflation then because of greedy workers, rather than firms? Neither EPI nor Groundwork have suggested so. Looking at the share of price rises like this is misleading too. Between Q2 and Q3 2023, prices did not increase significantly, so Groundwork was effectively calculating that a tiny change in prices could be accounted for by a similarly tiny rise in profits over that period.

In any case, this sort of analysis by accounting identity is terrible economics. Firms cannot just increase inflation by reaching for profits. If one firm raised prices for customers on that basis, then other competitors would undercut them. Even in markets where firms had more market power, consumers would have less money left over to demand other products, pushing other prices down and having little overall effect on measured inflation.

What about if most or all firms across the economy colluded to restrain output and increase prices at the same time? Then we’d have expected to see real GDP in the economy fall significantly to explain the level of inflation we saw in 2021 through 2023. Yet real GDP grew strongly in the period EPI complained about profits driving inflation and continued growing reasonably last year when Groundwork made the same complaint. So there’s little evidence of these huge effects in the macroeconomic data.

More importantly, the reason consumers have been able to pay these higher prices was because there was a huge increase in the money supply between early 2020 and mid-2022. If a central bank allows the money supply to get out of control, this can increase total spending power across the economy.

That extra demand for goods and services can produce rising consumer prices and rising profits across many sectors in the short term, not least because wages (a big cost for firms) tend to be stickier. Prices and profits thus rise at the same time, as does real GDP. Yet it was monetary excess causing all this, not greedy companies’ profits causing inflation. 

Price Gouging

Unfortunately, many Democrat politicians seem to think it illegitimate for firms (including grocery stores) to raise prices when demand for their product rises (as opposed to their costs going up). That way of thinking also seems to have infected their macroeconomic worldview: if rising prices across the economy at any period can’t be explained by firms’ rising costs, then it must be greed or excessive profit-seeking, rather than the first-order effects of too much macroeconomic stimulus.

If all this were just idle musings from populist politicians, that would be one thing. But Senator Warren and others have introduced federal legislation that would make it “unlawful for a person to sell or offer for sale a good or service at a grossly excessive price” during an “exceptional market shock.”

That is, they want to ban companies from “excessive” price increases following “a natural disaster, failure or shortage of electric power or other source of energy, concerted labor action, lockout, civil disorder, war, military action, national or local emergency, public health emergency, or any other cause of an atypical disruption in such market,” regardless of what has happened to demand.

This anti-price-gouging legislation would enshrine in law that firms couldn’t raise prices by more than the FTC considered justifiable, with the legislation suggesting this be capped at the level of prices charged pre-emergency or what the accused business’s competitors are charging. If this legislation had been in place during the pandemic, it would thus have acted as an effective price control across much of the economy suffering from excess demand. That would have been a recipe for prolonged shortages for many goods and services.

The legislation grants an affirmative defense to businesses accused of gouging only if they have revenues less than $100 million and can prove that price hikes arose due to additional business costs. For larger companies with US revenues above $1 billion or who discriminate between buyers from a dominant position, charging more than normal would be a presumed violation with potentially massive fines of “5 percent of the revenues earned by the person’s ultimate parent entity.”

Conclusion

Democratic politicians, including President Biden, are keen to suggest that companies are to blame for the high cost of groceries and shrinking package sizes. Both, however, are symptoms of higher inflation between 2021 and 2023, caused by too much macroeconomic stimulus relative to the economy’s propensity to produce goods and services.

In propagating this false narrative, the federal government isn’t just mis-educating voters about the ultimate causes of inflation. It is also fueling legislative attempts to control firms’ prices or pricing structures. Giving the FTC powers to judge shrinkflation an “unfair or deceptive act or practice” risks costly legal disputes and companies feeling forced to raise package prices, even when consumers might prefer fewer units of the product within a package. A federal anti-price-gouging law risks prolonging shortages of goods in high demand during emergencies. 

Last May, I wrote a piece called “We Are Measuring Inflation All Wrong: Non‐​housing Inflation Is Very Low.” That has not changed. The uniquely quirky way “shelter” costs are estimated by the US Bureau of Labor Statistics commands such a huge share of the Consumer Price Index (CPI) that it has overwhelmed everything else for nearly two years.

This is mostly due to “Owners’ Equivalent Rent” (OER) which accounts for an astonishing 26.8 percent of the CPI. Rent accounts for another 7.7 percent of the CPI, and hotels for 1 percent.

Owners’ equivalent rent purports to measure monthly variations in a price nobody pays, and to average those estimates for every house in the entire country. Nearly every other country wisely excludes such impossibly arbitrary OER estimates from their measure of inflation. Yet that singular made-up number dominates the US CPI, and to a lesser extent the Personal Consumption Expenditures (PCE) inflation index too.

Shelter accounts for 36.1 percent of the CPI and 42 percent of Core CPI. Shelter also accounts for 60 percent of measured inflation in non-energy services. This turns out to matter quite a lot, because estimated inflation for shelter has long been extremely high, while inflation for everything else has been extremely low.

The Graph shows that from July 2022 to January 2024, the average CPI inflation rate for shelter was 7 percent, yet the average inflation rate for everything else was only 1.2 percent. This January alone, the reported annual inflation rate for shelter was 6.9 percent, but inflation for everything else was 1.6 percent.

When the January CPI came out, Wall Street Journal reporters Justin Lahart and Nick Timiraos opined that, “Inflation eased again in January but came in above Wall Street’s expectations, clouding the Federal Reserve’s path to rate cuts and potentially giving the central bank breathing space to wait until the middle of the year.” That implied the Federal Open Market Committee might base the next few months’ interest rate manipulations on one month’s “unexpected” OER surge. It also implies that the Fed somehow imagines that keeping the interest rate on bank reserves far above the non-housing inflation rate could, in some inexplicable way, diminish future increases in rents.

Federal Reserve apologists prefer to naively accept such official shelter inflation statistics on faith — ostensibly believing that typical market rents have actually been rising at a 7 percent annual rate nationwide— rather than to even consider the possibility that the Bureau of Labor Statistics (BLS) has no idea how to estimate a national average of rents, much less an average of what all houses everywhere might rent for.

We know that is not true because the BLS now collects information about repeat rents for new tenants on the same housing units. The second graph shows that the BLS New Tenant Rent Index was much lower in the fourth quarter of 2023 than it was a year earlier.

If the U.S. measured consumer prices in the same “harmonized” way other countries do —by simply excluding dubious guesstimates of Owners’ Equivalent Rent— the average rate of inflation was 2.3 percent over the past twelve months, 1.1 percent over the past six, and zero over the past three.

Capital One recently announced plans to acquire Discover Financial Services with a $35.3 billion all-shares transaction. The proposed merger has brought the usual suspects out of the political woodwork to complain about financial concentration and increasing bank size.

For instance, Senate Banking Committee Chair Sherrod Brown (D‑OH) complained that a deal that “makes powerful financial companies even bigger and more powerful will do nothing for families.” Sen. Elizabeth Warren (D‑MA) echoed similar sentiments, saying the deal “threatens our financial stability, reduces competition, and would increase fees and credit costs for American families.”

Unsurprisingly, these critics who levy concerns about the size and power of private financial institutions show little concern about the balance sheet of the Federal Reserve—whose assets have grown exponentially since the financial crisis.

As of Q4 2023, Capital One and Discover reported total assets of $478.5 and $151.5 billion respectively (collectively about $630 billion). Their combined balance sheet represents less than 3 percent of the total assets held by commercial banks in the US. In the same quarter, the Fed reported average asset holdings of $7.8 trillion—over one-third the size of the entire US commercial banking sector. It is also double the $3.9 trillion in assets held by Chase, the largest bank in the US.

More troubling is the trend of the Fed’s increases in balance sheet size. Figure 1 shows the size of the Fed’s balance sheet in proportion to all US commercial banks. Prior to the 2008 financial crisis, the Fed’s balance sheet rarely exceeded 10 percent of the commercial banking sector, with the trend exhibiting a gentle decline. Since the financial crisis, the Fed entered a new era with this number frequently exceeding 20 percent. Since Covid-19, the Fed now holds so many assets that it is well over 30 percent, the size of all commercial banking.

To be fair, the Fed does attempt to reduce its balance sheet size following a massive surge. However, as Covid-19 demonstrated, if it is now expected to buy assets following every major economic shock, there is no way it will ever revert to a pre-financial crisis state.

Unlike private institutions, whose balance sheet increases do not harm the macroeconomy, the Fed purchases vast quantities of US treasuries to facilitate the government’s spending spree. Given the massive effects such fiscal expansion has on inflation and the role it played in the post-Covid price surge, Congress would do well to rein in the Fed’s balance sheet instead of debating mergers between private financial institutions.

The author thanks Jerome Famularo for providing research assistance during the preparation of this essay. All data used in this analysis was collected from the FRED website.

Initial Victories

Javier Milei’s first two months in office supplied a steady stream of good news to libertarians worldwide. There was the presidential decree that deregulates large swathes of the economy, the brilliant speech at Davos—endorsed by the likes of Tesla’s Elon Musk and historian Niall Ferguson— and the government’s introduction of its “omnibus” law, a bill designed, among other things, to privatize dozens of state-owned companies. 

The only initial setback for Milei’s government was a January 30 court ruling that declared the presidential decree’s labor reform unconstitutional. Nonetheless, the government took this in stride while it adapted certain parts of the omnibus bill so as to ensure its approval in Congress. The entire content on fiscal matters, for instance, was removed, a measure some libertarians celebrated since the law had originally included tax hikes.

A buoyant mood turned outright cheerful on February 2, when the Lower House of Congress approved the omnibus bill in general terms by a 144 to 109 margin. Milei seemed to be sailing smoothly toward a full recovery of Argentina’s lost “model of freedom,” as he termed the country’s successful, nineteenth century experiment with free trade and free markets.

A Rude Awakening

Nonetheless, the narrative changed abruptly on February 5, when the Lower House voted on the omnibus bill article by article and a majority rejected its key elements, among them the privatization scheme and increased penalties for the use of violence in protests. In effect, Milei’s honeymoon period came to an abrupt end with the onset of political reality.

After all, Milei’s party, Liberty Advances, only controls around 15 percent of the lower house of Congress and under 10 percent of the Senate. Even with the support of the Republican Proposal, the party of former president Mauricio Macri, a Milei ally, the government’s legislative forces fall well short of any type of majority. In fact, the omnibus bill was only set to pass due to the support of smaller parties linked to several provincial governors.

Since Milei ordered the bill to return to committee, the government will start from square one when it comes to measures that, unlike the content of the December “mega-decree,” require legislative approval. At the moment, therefore, the government’s ability to pass its agenda has become more uncertain.

A Blessing in Disguise

Regardless, Milei should treat his recent legislative defeat as a blessing in disguise. The contretemps offers an opportunity to rethink his political strategy. Milei should focus on the one, fundamental measure that is most urgent for Argentina, and at the same time neither requires the approval of Congress nor is liable to being reversed by any future government.

That is, Milei should finally act on his flagship campaign promise of dollarizing Argentina’s economy and shutting down the central bank. 

As we argued recently, the government’s current strategy of keeping the peso in order to dilute both the debt and the deficit might serve to solve Argentina’s fiscal problem on paper. The corollary is the necessary dilution of peso holders’ savings and purchasing power. The dilemma exposes the fundamental flaw of Finance Minister Luis Caputo’s economic plan: it involves maintaining high inflation levels—the most pernicious of taxes— for the sake of the government’s balance sheet. This despite Milei’s unequivocal campaign promise of “destroying” inflation, which had already reached triple digits when he won the presidential election in November.

Balanced budgets are, of course, desirable and necessary, to the extent that, as Warren Buffett has proposed, politicians who run deficits should be ineligible for reelection. Nonetheless, the methods through which balance is achieved matters as much as the achievement itself. After all, the Soviet Union reported fiscal surpluses for over 60 years prior to its eventual economic and moral collapse.

In Argentina’s case, the root cause of the country’s economic problems is politicians’ unfettered fiscal profligacy, with chronic deficits monetized by means of a subservient central bank. At this point, however, addressing the fiscal question without taking the monetary problem head on is a mistake. We are not alone in our assessment. 

Cavallo’s Sound Warning

Domingo Cavallo is a former finance minister of Argentina who knows a thing or two about slashing inflation rapidly. As an architect of the country’s “convertibility” system of the 1990’s, which fixed the peso’s exchange rate to the dollar (albeit with significant design flaws), Cavallo helped to reduce Argentina’s annual inflation levels from 2,600 percent in 1989–1990 to 25 percent in 1992 and under 1 percent by 1998. In a blog post published on January 31, Cavallo wrote the following:

“The best way to generate expectations of an accelerated decrease (in inflation) in 2024 is for President Milei to reassume his sermonizing on dollarization, so that, by 2025, no trace of exchange rate controls remains and there is a stabilization plan that can eradicate inflation, just as the convertibility plan did in 1991.”

Cavallo adds the following, crucial warning:

“No one will believe that the dollarization proposal is serious as long as the free purchase and sale of dollars remains illegal. It is essential that a free exchange rate be allowed to operate without any type of interference from the central bank, so that any natural or legal person may sell or buy foreign currency.”

Ending exchange rate controls is certainly urgent, as is the elimination of the central bank’s control over all trade operations. As we wrote on January 19, it makes little sense for Milei’s government to uphold the central bank’s monopoly on the sale of dollars in the midst of a deregulation spree. Once importers and other economic actors are allowed to buy foreign currency in a free market, the central bank’s limited amount of dollars—a theoretical obstacle to dollarization— becomes irrelevant. As in the case of Milei’s successful elimination of rent controls, the end of government intervention will produce abundant, pent-up supply.

Cavallo raises a further concern about the real exchange rate, which takes into account the price of goods in the two countries being compared to gain a better picture of the value of both currencies. Argentina’s real exchange rate, he writes, has decreased despite lower inflation levels in January compared to December, when Caputo adjusted the official dollar-peso rate from ARS $400 to ARS $800 (compared to a black market, “blue dollar” rate of around ARS $1,000 at the time). A further reduction of the real exchange rate in February, Cavallo wrote, could lead to “pressure for further devaluation” in March. Milei, however, was elected on a platform that promised a strong and stable currency, not further devaluations.

Hence the concern with Milei’s reticence about dollarization, which he has only mentioned in recent months to confirm his past pledge to end the peso monopoly, but only eventually and without any details in terms of when or how to do so. In practice, however, the government’s plan is inconsistent with dollarization and its immediate effect of precluding any manipulation of a national currency.

The “Lack of Dollars” Fallacy

Financial journalist Julián Guarino added some context to Cavallo’s pronouncement:

“Casa Rosada [the government] and Caputo are feeding inflation to clean up the Central Bank’s balance sheet by diluting the debt and public spending (the Treasury). But, at the same time, inflation is defying all expectations. In other words, the government is driving inflation, which contradicts the government’s supposed aim of reducing inflation. This is why all eyes are on the central bank.”

Guarino further comments that, under the assumption that dollarization requires the central bank to hold net reserves equal to all liabilities on its balance sheet, “the Milei-Caputo plan could come up short by failing to amass sufficient dollars [to dollarize], which would be the worst-case scenario.” 

The Caputo plan is falling short, albeit not for the alleged “lack of dollars” in Argentina. As we have written repeatedly, Argentines—namely individuals and businesses—have plenty of dollars (well over 50 percent of GDP), which they deliberately keep outside of the formal financial system. The inflow of even a portion of these assets into deposits—as likely would occur with the mere announcement of dollarization— would cover the entirety of the monetary base, which stood at around USD $12 billion at the official exchange rate on February 8.

Nonetheless, the essential point that Milei and his advisers should understand now is that the central bank already has more than enough dollars to dollarize.

The reason is that dollarization is a two-step process. As Steve Hanke and Francisco Zalles recently wrote concerning the first step:

“…with the exception of peso notes and coins outstanding, a stroke of the pen is all that is required to redenominate peso assets and liabilities into greenbacks.”

The second, parallel step involves dollarizing the circulating currency (peso notes and coins outstanding). In this sense, Hanke and Zalles explain that, contrary to the theory that the central bank needs a certain amount of net reserves to dollarize, “it is gross liquid foreign-exchange reserves that are relevant, not net reserves.” In terms of this key metric:

“As of December 31 and at Argentina’s official exchange rate, the BCRA [Banco Central de la República Argentina] reported ‘International Reserves’ of AR $18,654 billion pesos (US $23.1 billion), significantly more than the AR $7,435 billion (US $9.2 billion) in ‘Banknotes and Coins in Circulation.’”

Since international reserves are “liquid unencumbered gross reserves,” their stock “is more than adequate to successfully convert Argentina’s stock of peso notes and coins into U.S. dollars.” (Emphasis added)

Concerning the conversion of the USD $9 billion or so of circulating currency into dollars, Milei’s government should keep in mind that this involves a process in and of itself. As such, all banknotes and coins will not be dollarized at a moment’s notice. Rather, the conversion of the circulating currency into dollars takes place over a period of time during which both currencies circulate simultaneously, at the exchange rate at which dollarization is announced.

As we wrote previously, in 2000, Ecuador dollarized all sucres (the former national currency) in circulation within a nine-month period mandated by the government. In El Salvador, citizens voluntarily converted 90 percent of colones (the former national currency) into dollars within a 24-month period that began in 2001.

The Need to Dollarize Now

A prudent option for Argentina would be to mandate a 24-month period for the dollarization of all pesos in circulation at the determined exchange rate. How can the government ascertain the latter? Hanke and Zalles propose an official announcement of dollarization followed by a 30-day period in which the exchange rate would settle freely. The prevalent rate at the end of said period would be the official dollarization rate.

An alternative at this moment—given that exchange rate controls remain in place— would be to announce dollarization at a rate slightly above the “blue dollar” rate, which is the closest available figure to a free-market rate of exchange.

In terms of converting circulating pesos to dollars, any logistical challenge is clearly surmountable. In Ecuador, for instance, the government relied on the Coca‐​Cola Company’s supply network to exchange dollars for sucres in remote rural areas.

However, Milei’s government must dollarize soon to avoid the possibility of dollarization being incomplete at the time of the next election. The potential victory in 2027 of an anti-dollarization candidate could derail the process, or at least lead to an attempt to sabotage dollarization while pesos still circulate. Luckily, however, Milei has had an electoral mandate to dollarize since the very first day of his term in office.

As Cavallo argues, a prompt dollarization would lead to a sharp decrease in inflation. If the process is complete well before the 2027 presidential election, this alone—ceteris paribus—should win Milei a second term in office. Nonetheless, even if Milei is not reelected, dollarization and the subsequent end to high inflation will cement his legacy in the long term. Once accustomed to the use of a strong currency, few if any Argentines will accept the reintroduction of the peso or any other means of exchange that politicians can manipulate at will.

In Ecuador, for instance, dollarization has enjoyed approval levels of 90 percent and above for years; the dollar’s popularity even outstripped by far that of left-wing strongman Rafael Correa during his heyday. Hence the utter failure of Correa’s attempt to de-dollarize. Given the not unlikely scenario of Peronism’s eventual return to power in Argentina, Milei should make sure that dollarization has taken place well within the limits of his current term.

How to Dollarize: The Constitutional Question

While the main objection to dollarization in Argentina has been financial (and erroneous)—the supposed lack of dollars—the only potential obstacle is constitutional and political. As Article 75 of Argentina’s constitution states, “it pertains to Congress” to:

• “Establish and regulate a federal bank with the power to issue currency, as well as other national banks…” (Section 6)
• “Have currency stamped, fix its value and that of foreign ones…” (Section 11)
• “Provide what is conducive… to the defense of the value of the currency.” (Section 19)

From a legal perspective, some commentators argue that Congress’s mandate to “establish” a federal bank “with the power to issue currency” precludes the possibility of dollarization since it would be unconstitutional. However, economist Emilio Ocampo rightly points out that—beyond Congress’s obvious, century-long violation of the mandate to defend the Argentine currency’s value— the aforementioned legal arguments fail to take into account the myriad ways in which dollarization can take place.

Consider the fact, for instance, that the National Bank of Panama, which is a state-owned commercial bank (not a central bank), mints balboa coins that are of equal denomination to the coins that circulate in the United States: cents, nickels, dimes, quarters, half dollars, and dollar coins. In a strict sense, then, Panama, a dollarized country since soon after its independence from Colombia in 1903, still issues a national currency, albeit with a fundamental restriction: it is limited to coins that are equivalent to their American counterparts.

Argentina could do the same in order for Congress to meet the constitutional mandate to ensure that a currency is “stamped,” and its value “fixed.” It could do so, for instance, through the state-owned Banco de la Nación Argentina, a commercial bank, even after its intended privatization. Ocampo makes the additional point that the central bank was never established as a “federal bank.” Hence, Milei could shut down the central bank by executive order, much in the same way as he got rid of ministries, secretariats, and undersecretariats.

Since the Argentine government already fixes an official exchange rate without needing to go through Congress, it also could set the rate at which all pesos would cease to circulate (for instance, during the suggested 24-month-period.) In other words, it is perfectly feasible for Argentina to dollarize without Congress’s approval and without removing Congress’s constitutional mandate to issue currency.

Indeed, Argentina’s dollarization is the one, certain way to ensure that, in the future, Congress can meet its constitutional duty—set out in the original, classical liberal version of 1853—to defend the currency’s value. Without moves to dollarize soon, a lasting return to the model of freedom which Milei was elected to restore will become out of reach.

Today (February 14) marks the two-year anniversary of Prime Minister Justin Trudeau’s decision to invoke the Emergencies Act for the first time in Canadian history. The decision was made in order to shut down the Freedom Convoy—a protest organized against government overreach during the COVID-19 pandemic.

At the time, my Cato colleagues Norbert Michel, Walter Olson, and I spoke out against the decision because it marked both an attack on freedom in the current financial system and a cautionary tale of what might happen with central bank digital currency (CBDC) in the future. Yet, looking back, there are even more reasons to oppose Prime Minister Trudeau’s use of the Emergencies Act.

Three Strikes

Although it was largely the Emergencies Act that drew international criticism, the Canadian government tightened its hold on the financial system long before Prime Minister Trudeau’s official announcement. In fact, the experience highlights all too well the extent to which governments can readily pressure and control the financial system with existing tools.

The first strike came on February 2, 2022, shortly after GoFundMe—the primary platform for official donations to the Freedom Convoy—paused all donations to review the protest and make sure the organizers were not violating the platform’s terms of service. The Canadian House of Commons Committee on Public Safety and National Security quickly voted unanimously to have GoFundMe testify before it to “ensure the funds are not being used to promote extremism, white supremacy, anti-Semitism and other forms of hate, which have been expressed among prominent organizers for the truck convoy currently in Ottawa.”

With both the Canadian House of Commons and law enforcement crowding around it, GoFundMe announced the next day that it removed the donation page for the protest and froze the accounts following “evidence from law enforcement that the previously peaceful demonstration has become an occupation, with police reports of violence and other unlawful activity.”

The second strike came on February 10, 2022, when the Ontario Superior Court of Justice granted a request from the provincial government to freeze millions of dollars raised on GiveSendGo (the platform chosen after GoFundMe could no longer be used). The decision marked a clear escalation of the government’s response. However, many protestors remained undeterred.

The third, and final, strike came on February 14, 2022, when Prime Minister Trudeau announced that he had invoked the Emergencies Act for the first time since the Act was passed in 1988 and thus authorized the government to take extraordinary measures to respond to the protesters that remained on the streets.

Deputy Prime Minister and Finance Minister Chrystia Freeland explained that the financial activity of protestors could be frozen without a court order:

In invoking the Emergencies Act, we are … broadening the scope of Canada’s anti‐​money laundering and terrorist financing rules so that they cover crowdfunding platforms and the payments service providers they use. These changes cover all forms of transactions––including digital assets such as cryptocurrencies… As of today, a bank or other financial service provider will be able to immediately freeze or suspend an account without a court order.

Taken together, the experience illustrates how governments will use pressure, court orders, and sweeping authorities to use the financial system as a means of control.

A Decision Without Cause

Yet it’s not just the escalating measures that warrant concern. There’s still the question of whether the government was justified in invoking these emergency powers in the first place.

Back in 2022, the Canadian Civil Liberties Association objected to the use of the Emergencies Act saying,

The federal government has not met the threshold necessary to invoke the Emergencies Act. This law creates a high and clear standard for good reason: the Act allows government to bypass ordinary democratic processes. This standard has not been met.

Today, the courts seem to agree. On January 23, 2024, a federal judge concluded that “there was no national emergency justifying the invocation of the Emergencies Act and the decision to do so was therefore unreasonable and ultra vires.” (The Canadian government announced that it will appeal the decision.)

Conclusion

Prior to Prime Minister Trudeau’s decision, freezing the bank accounts of protestors had been a strategy only used by authoritarian regimes, not one of the freest nations in the world. As Walter Olson warned at the time, the decision underscores “how dangerous it is to arm the government with the kind of financial and emergency powers that can bypass due process, bring targets to their knees through economic incapacitation without trial, and shred privacy.”

Whether you agree with the protestors or not, moments like these should be a wake-up call for how quickly governments can amass and enforce sweeping powers that can stop people in their tracks.

Researchers at the Atlantic Council say the United States is falling behind on central bank digital currency, or CBDC, development. But is it really? According to the Human Rights Foundation’s CBDC Tracker, the Federal Reserve has been conducting research and pilot programs for years. However, even if those developments do not meet the Atlantic Council’s standards, there’s no need to enter a race to the bottom by creating a CBDC. 

A Thumb on the Scale?

The Atlantic Council’s report opens by immediately informing readers that the European Central Bank, the Bank of England, the Bank of Japan, the Reserve Bank of India, and the People’s Bank of China “have all made significant strides forward in their development of central bank digital currencies (CBDC[s]) and fast payment systems.”

Curiously, however, it’s not until the end of the piece that the researchers acknowledge that the Federal Reserve Bank of New York has been working on Project Cedar—a project to test wholesale CBDC designs. Even then, though, it’s not just the Federal Reserve Bank of New York and it’s not just Project Cedar.

According to the Human Rights Foundation’s CBDC Tracker, the Federal Reserve Bank of New York also announced work on a CBDC proof-of-concept project. Furthermore, the Federal Reserve Bank of Boston announced Project Hamilton to build and test a “hypothetical central bank digital currency for wide-scale, general purpose use.” To coordinate efforts, the Biden administration called for “the creation of a Treasury‐​led interagency working group to support the Federal Reserve’s efforts.” And finally, the Federal Reserve has been publishing CBDC research.

So, the United States has been quite active on the CBDC front.

Proponent’s Miscalculation

With that said, CBDCs that have been launched to the public already offer a cautionary tale. The Chinese government has given out millions of dollars in CBDC lotteries in an attempt to spur adoption. For example, in Shenzhen, $1.5 million in CBDC was given to 50,000 people. In Suzhou, $3.1 million in CBDC was given to 100,000 people. Yet the effort was less than successful. A former People’s Bank of China research director said, “The results are not ideal … usage has been low, highly inactive.”

The Chinese government handing out millions of dollars to try to get people to use the CBDC highlights what’s probably the biggest miscalculation among CBDC proponents: the failure to identify a sound justification for the creation of a CBDC in the first place.

When Meta proposed creating a cryptocurrency in 2019, government officials quickly latched on to the idea of launching a CBDC to combat the market and protect the government’s monopoly on money issuance. Yet, as that story faded and interest waned, organizations pushing CBDCs tried to re-position the idea as a solution for financial inclusion, faster payments, monetary policy, and currency adoption. While these areas have all been due for improvement, Norbert Michel and I have explained at length that none of these benefits are likely to come from the creation of a CBDC.

Therefore, it seems proponents have now turned to the argument that the United States should create a CBDC so that it can influence other countries to do it the “right way.” In urging the Federal Reserve to do more, the Atlantic Council writes,

What’s concerning about this approach from the Fed is that central bankers around the world are asking for the Fed’s help. Central bankers often privately ask some version of: “Where is the Fed on this?” On a range of issues from privacy to cybersecurity, the Fed’s leadership would be welcome and its guidance and technological expertise listened to, even if the United States doesn’t determine there’s a need for a specific kind of payments innovation in its own domestic system.

First, the Federal Reserve does not exist to act as a consultant for foreign governments. A US CBDC should not be created on these grounds. Second, if it is concerning for central bankers that the Federal Reserve has not launched a CBDC, perhaps they too should reconsider launching one.

Conclusion

The Atlantic Council is right to say that the dollar should be improved, but the creation of a CBDC would not be an improvement for American citizens. In fact, based on the Human Rights Foundation’s CBDC Tracker, it doesn’t seem that a CBDC has been an improvement for much of anyone around the world.

If Congress wants to make positive changes for the dollar, it should look to strengthening financial privacy, promoting currency competition, and creating a freer financial system.