How To Dollarize Argentina, Exactly
How To Dollarize Argentina, Exactly
A discussion with Nicolás Cachanosky on The Rasheed Griffith Show
Full Transcript Below
Show notes
In this fascinating episode, we dive into a more nuanced discussion for implementing dollarization in Argentina. Nicolás Cachanosky joins our Executive Director, Rasheed Griffith, for a detailed and technical rundown of the steps needed to transition the beleaguered economy to the US Dollar.
Firstly, there's the equilibrium rate. How many pesos would be needed to redeem one US dollar? How would this price be established? The government could remove the country's capital controls, which have been used to maintain an inflated and unsustainable rate. This would allow the market to determine a new rate at which the country would dollarize.
Secondly, you must dollarize the bank deposits. The checking and savings accounts of citizens and businesses must be converted to USD. This is the most straightforward step, as this form of money is purely digital. Bank deposits also act as a method of converting the physical currency into dollars when withdrawals are processed and redeemed in USD.
Thirdly, there's the dollarization of the central bank. Argentina's central bank is insolvent. Government bonds would be a viable solution if Argentina's trust rating on global markets weren't firmly in junk territory. To get around this problem, Cachanosky suggests using a special purpose vehicle, transferable bonds, equities, and other financial instruments based on assets in the government's portfolio, such as pensions and health insurance.
None of this can happen in a vacuum. Measures will also need to be taken to ensure that the policy changes are concrete enough to withstand a regime change. If successful, it could cause a cascade of financial reform across the Southern Cone and usher in a new financial era in Latin America.
Recommended
Dolarización - Solucion Para Argentina - Emilio Ocampo, Nicolás Cachanosky
Así dolarizamos al Ecuador - Jamil Mahuad
How to Dollarize Argentina - Nicolás Cachanosky
Previous Episodes
Ep. 16: Dollarization: A Solution for Argentina with Emilio Ocampo
Ep. 27: The Inside Story of Dollarization in El Salvador with Manuel Hinds
Full Transcript
This transcript was automatically generated by AI and lightly edited by our team. We don’t catch every error, so if you spot one, send us a message/email via shem@cpsi.org.
Rasheed: Hello, Nicolas, and thank you so much for joining me on the podcast today.
Nicolás: Hello everyone. And thank you for having me.
Rasheed: I want to discuss the dollarization process in Argentina from a more technical details-oriented perspective. We've previously done an episode with Emilio Ocampo, who is your co-author, on your very fun-to-read book, 'Dolarización: Una Solución para la Argentina'.
And we have the background about why it's good and some of the basic theoretical critiques about dollarization. But I do want to dig in deeper to figure out, okay, we agree, let's do this. But how exactly do we do this?
Nicolás: That's a question that comes up a lot. "Fine, but how do you do it?" Because you can agree that it may be a good idea, but that doesn't mean you can do it.
Something to keep in mind is dollarization, what's dollarization is, right? You are doing away with your own currency and you replace it with a foreign currency. In the case of Argentina, that would be the U.S. dollar. So we're talking about major surgery here. This is not a minor policy change. So that's why there is so much attention.
Okay, but how do you do it and do it safely? Okay. So the way I try to explain this is to divide what needs to be dollarized in three different groups or areas, just to conceptually identify the different approaches that you are going to have to get. Dollarization is not like a one size fits all countries, different countries dollarize different ways.
Ecuador dollarized differently than El Salvador, different than Panama, different than Zimbabwe. So each country needs to adapt how you're going to dollarize to your needs and your objectives. So what are the three things, the three areas that you have to dollarize? One is bank deposits. Another one is the currency in circulation, so the peso bills that people have in their wallets. And the third one, and this is very particular for the Argentine situation, are the central bank liabilities, which are denominated in pesos.
So before I go into each one of these three, let me clarify that when you are changing your pesos or your local currency for the U.S. dollar or whatever currency you're going to be dollarizing to, you need to decide your conversion rate, like what exchange rate you're going to use to dollarize. This is a very hot topic of debate in Argentina because many of the critics say you don't have enough dollars to dollarize. Therefore, the only way you can do it is at an exchange rate that is so far from what you have right now that this requires such a currency depreciation that is not doable.
So conceptually speaking, if you dollarize at the exchange rate of equilibrium, you don't dollarize at any rate. Of course, if the, I don't know, the market rate is, I don't know, 800 pesos to the dollar, you're not going to dollarize 8,000 to one dollar, right? That's out of the question. So that's pointless. So the concept is if I'm in Argentina and I get my, I don't know, wages, you know, paid in pesos at the end of the month, and then I go and I buy dollars in whatever way I can because if the government is not selling me dollars and I need to go to the black market, it doesn't matter.
When I get my pesos, that's equivalent to a certain amount of dollars I can get. If you dollarize, when you get paid your wage, you get the same amount of dollars. So that's conceptually speaking the exchange rate around which you are gonna dollarize. Maybe you do it a little below, a little above, whatever, but the point is that you dollarize around your equilibrium rate.
Okay, so to clarify that, let's start with the first one, bank deposits. This is the area that is maybe the fastest and easiest to dollarize.
Rasheed: Sorry, before you do that, could we give some more detail exactly about how you determine the equilibrium rate? What would have to be done for it to be satisfied that the equilibrium rate has been reached?
Nicolás: Argentina has capital controls, so, or at least it had before. The capital controls are still there, which means if you're in Argentina and you want to buy dollars, you can't. You need government permission. The reason for that, why we have that, is because the official exchange rate is way off of equilibrium.
So there is a shortage of dollars. The central bank starts to run out of dollars because they are cheap. And so instead of adjusting the price, they restrict the quantity. That's the capital control. Something that needed to happen, whether you dollarize or not, and this is something to keep in mind, right, Argentina needs to do several things regardless of whether they dollarize or not.
So one of the things that needed to happen was to adjust the exchange rate, the official exchange rate. How do you decide at which rate you dollarize? One way is you try to make an estimation, and you use your estimation as your guide at which rate you dollarize. I know the exchange rate is out of equilibrium, but my team of economists estimates that the equilibrium rate will be a thousand pesos.
And then you dollarize at that level. Another way is to remove the capital controls and let the market tell you what the equilibrium rate is gonna be. In that situation, you have the market feeding you some information. Now, some people may react that, but this implies a big depreciation of the peso and that can be very costly.
And once again, that needs to happen even if you don't dollarize. This is not a dollarization problem. And this is a peso problem whether you dollarize or not. And that's what we saw, right? Milei took office and one of the first things they did was a very big depreciation of the peso. The capital controls are still there and dollarization was not announced.
So that goes to the point that this currency correction, the exchange rate correction needed to happen with or without dollarization. So those are the two basic approaches. You try to estimate where the equilibrium is, or you remove the capital controls if you can, and you let the market tell you where the equilibrium rate is.
Rasheed: And which would you prefer, the capital control elimination or estimation?
Nicolás: It's tricky because one of the problems that Argentina has is the central bank liabilities, which are short-term debt. That is a central bank issue that can very quickly go to the exchange rate market to buy dollars. You may have to maybe find a combination if you are afraid that the market may run to the exchange rate markets faster than you announce dollarization.
That's one of the tricky parts of how to dollarize Argentina. And that's an area in our proposal, we pay special attention to how you deal with the central bank liabilities because you can't ignore them.
Rasheed: And we'll get to that pretty soon.
Nicolás: And my understanding is that the reason why the Argentine government hasn’t removed the capital controls yet is because they're afraid of this.
So they're trying to clean up these central bank liabilities before they remove the capital controls. But besides these problems, I mean, they're important. I'm not saying they're not, but I want to conceptually explain how dollarization happens through these packets. So when you're thinking about the bank deposits, this is probably the fastest and easiest to dollarize because you set, however, you do, you set your dollarization rate and then I log in tomorrow online to my bank account and my peso deposits were transformed at the conversion rate into dollars.
Before dollarization, if I were to withdraw all my deposits and buy dollars in the market, those are the dollars I was going to get anyway. Now, all my deposits, and everything in the banking system are dollarized and that happens fast. Because it's just a change in the unit of account in your bank deposit.
Now, the concern with dollarizing the bank deposits is, what if you have a bank run? You are now telling the Argentines that their pesos in the banks now are dollars. What if they go to the banks intending to withdraw the dollars and keep the dollars out of the banks? Because we know Argentina, everyone is afraid of the banks and does not trust the banks, deeming that these dollars are safer at my home than at the bank.
There are a few reasons why, if you are dollarizing, it is a necessary component of a set of reforms. It's not intended to replace other reforms. We see it as something that you have to do, but it won't be sufficient to fix the country. So what are some reasons why a massive bank run would be unlikely in Argentina?
I'm going to give you a few, but one is what happened in Ecuador, which dollarized in a similar context, political crisis, getting out of a banking crisis when they dollarized. What happened was an inflow of money to the banks, not an outflow. Even if banks were offering a negative return on those deposits. So the little empirical experience we have points in the opposite direction.
And even if empirical evidence is little, that doesn't mean you can ignore it, right? I still have to see what happened in the little evidence we have. But there are other reasons. If you look at Argentine banks, most of the deposits are for transactions. It's a transaction of deposits. I need to pay wages.
I need to pay my suppliers. I need to pay taxes. I need a bank account to collect my payments proceeds from sales. So this is money that I need in the bank because I'm using the banks as a payment technology. I need to transfer money and receive money. So even if I take the money away, I will have to put it back in the bank so I can pay wages for our employees and my providers and so on.
It's not money that is sitting in the banks making financial investments and now I need to take it out and buy dollars. No, I need to make these transactions. Even if that money goes up, it will have to go back. Another reason is that if you are taking the money away without the intention to put it back in the bank, you don't have the money in the bank.
So now your purchases are going to have to be in cash, but you won't have a small change in dollars in Argentina at the beginning of dollarization. You only have large denominated bills, $100 bills, that's it. So you are going to need, and you're going to want if you use cash, Pesos so that you can make small change purchases with pesos.
Now, if you are in the dollarization process, you don't mind that you have the pesos because it's already at a fixed conversion rate, you know that value is fixed, and you can very easily convert these pesos into dollars. One way is to make a bank deposit because if dollarized, that deposit will become dollars.
Another way is you pay your taxes in pesos and when your taxes go to the government accounts, they will become dollarized. Another way to get, to get rid of those pesos is you give them as a payment when you make a purchase and the business person doesn't mind getting those pesos because he knows he can use them to pay taxes or he can put them into his business account and it will be dollarized.
Having a small change of cash in pesos won't be an issue. So even if I want to withdraw money and the assumption is I want to take the money and not put it back in the bank and then I need to use it for paying purchases, I will need pesos because I won't be able to use the dollars. Another thing that banks can do is if they don't have all these dollars you want, they can give you these Visa cards with the amount you want to withdraw in dollars already charged to the card and you can swipe it and the payments will go through.
And this is good for you. One it's more pragmatic. They don't have to. be around with the dollar bills, you have one card. And two it's more safe because if the visa card comes with a pin, then there's no point in stealing the visa card from you, but I can steal the cash from you. So it's safer in Argentina to have a card that a thief cannot use than having the dollars as a temptation for anyone.
The reform also includes a banking reform to improve the safety of your deposit. So the idea is to have a private bank In an international jurisdiction, in the book we call this Argentine Reserve Bank, whose only mission is to be custodial and protector of private bank reserves. So I make a deposit in my bank in Argentina, but the reserves are not held at the central bank, they're held at the bank in Switzerland or Ireland or New Zealand or somewhere else, where the Argentine government has no jurisdiction.
One of the features of this is that now it's easier and faster for me as a depositor to move my money away from that bank than it is for the government to ask the banks to bring the money back and then seize it. I can go into my phone and with a couple of clicks I can move my money around from my bank in Argentina to somewhere else and now the government cannot do it.
So because the public can move faster than the government, that works as a defense mechanism against these expropriations. Now, there are other couple of items that will be more clear when we talk about the central bank liabilities, but through the dollarization process, when we liquidate, when the central bank is liquidated, you have a way to provide some dollars to the banks if needed.
Rasheed: Before you go on, the idea of the international private bank outside of the jurisdiction of Argentina, could you give some more details on why that's a necessary component?
Nicolás: I don't see it as a necessary component of dollarization, but I see it as a value-added component, especially for Argentina. This idea came out of seeing how dollarization took place in other places.
In Ecuador, Rafael Correa mandated the Ecuadorian banks to bring the money bank to Ecuador, and it had to be deposited at the central bank. And then, Ecuador said, give me those dollars, Central Bank in exchange take this treasury bond and Ecuador was able to seize a lot of money from commercial banks that way.
So that's why for Argentina, which has so weak institutions, the proposal is once you have to shut down the central bank because now makes all this process much more difficult and to have the custodial of the reserves outside the country. And that's not normal Ecuadorian banks were having their deposits outside of Ecuador.
So what we are saying is you can have one bank just dedicated to this. It's not out of the common. And in Zimbabwe, when Zimbabwe, the dollar rises and they go back to three-digit inflation, they use a similar process through the central bank. In my view, to keep the central bank if you are going to dollarize, especially in Argentina, is to take an unnecessary risk.
You don't need to have a central bank if you're dollarizing. We know that from Panama, for instance. Panama has been dollarized for more than a hundred years and it never had a central bank. You don't need to have a central bank if you're dollarized. For Argentina, we see it as very risky. And in Ecuador, they had problems with that.
Once you dollarize your bank deposits, the amount of dollars, Cash physical dollars that you need exactly not that much. What you need to change is the reserves in pesos for dollars, but you don't need to change all the nominal amounts of your bank deposits because that's digital money. Now, if you're going to have a bank run, of course, you need more dollars, but the point -it's that likely, and as was mentioned before, it's not very likely for Argentina, and you have some ways to still deal with that. That's the general approach for bank deposits. Conceptually, besides the challenges of the bank or not, how to do it is easy. Just switch from pesos to dollars, the conversion rate and the central bank will take the pesos in the bank reserves and transform that into dollars, which is not a large amount.
The other component of dollarizing is what you do with the currency in circulation. In Argentina, there are a lot of pesos in the hands of the public. So there are different ways to deal with this. For instance, in Ecuador, they gave originally a nine-month period within which the sucres had to be changed for U.S. dollars. After those nine months, the sucres are not valid anymore. So the central bank has to change those currencies in nine months. The first point to note is that when you dollarize your circulation, that doesn't happen overnight. It's not that Argentina announces dollarization and tomorrow you're going to have a line of 40 million Argentines at the doors of the central bank waiting to change their pesos.
This is going to take several months, so you don't need all those dollars on day one. You need them for a large number of months. El Salvador did something different. El Salvador said, these colones, don't lose validity. Do you want to dollarize them? Make a bank deposit. Pay taxes. So, if your currency, the peso in Argentina, is not gonna lose validity, the central bank is not obligated to change it for dollars.
They can say, In theory, the central bank, those are my pesos. They are valid forever. I don't need to buy them for dollars. Do you want to make them dollars? Make your bank deposit, and pay taxes. So in this case, you don't even need dollars to change the currency circulation, and you see this in Ecuador. I mentioned before, that when they announced the legislation, you have an inflow of money to the banks.
So if you look at the Ecuadorian central bank reserves, currency circulation is going down because it's being dollarized. It's not going down. Deposits are going up. So there was a large amount of the dollarization in Ecuador that took place through the private sector, not through the central bank. In Argentina, you can do a combination of these two approaches.
You can say, okay, we are going to start, let's just make round numbers with the peso. It's not going to lose validity. But 12 months from now, we're going to see how many pesos in circulation are left. So if the amount of pesos in circulations falls below a certain threshold, I don't know, 30 percent or whatever number you choose, this is like an automatic referendum.
Okay, the public voted, they don't want the pesos. So now, one year from now, you switch to an Ecuadorian style where the dollarization of the currency is mandatory, and now the Central Bank has one year, let's say, to change the remaining pesos for dollars. And that gives you an important advantage. One is, or two, the central bank doesn't need to have the dollars to dollarize today.
It can wait one year to increase its reserves. Two, the amount of pesos they will have to dollarize is much less than the initial amount on day zero.
Rasheed: So why not do the full El Salvador idea where you continuously allow pesos to be followed until they essentially go out voluntarily?
Nicolás: That's one option.
The reason why you may want to think for Argentina to, if you cross this threshold and go to the Ecuadorian style and you have to remove the pesos is to close as many doors as possible for the government in Argentina to go back and issue pesos. Argentine governments can be very creative in how to seize resources from the public.
And let me make a parenthesis here because you are referring to something important. Most people think of dollarization as an endgame. You dollarize, boom, you're done. I see more dollarization as a potential breach. The fact that you dollarize doesn't mean you cannot de-dollarize. It's difficult, of course, but it's not impossible.
Zimbabwe de-dollarized in a bad way, but the point is that to de-dollarize, if you remove the pesos and you need to launch a new currency, you have to be credible. If you are not credible, you cannot de-dollarize. That happened in Korea. Korea tried to issue its own digital currency and it failed because it's not credible.
Dominicana (Dominican Republic), I think, when they de-dollarized, they were credible and they had a lower inflation rate than the U. S. Something that the realization gives you is like a separating equilibrium. You're a bad actor. It's very difficult for you to de-dollarize. You are credible. You may be able to de-dollarize. So let's say that Argentina wants and would be better, I don't know, just For making the argument to have, this is one of the proposals, convertibility with the Brazilian real, I don't know, or pick any monetary regime you prefer over dollarization.
Like currency competition, the peso and the dollar, compete on equal foot in Argentina, like happens in Uruguay and other countries. I think it's easier to get a regime like that if that's what you want. After you dollarize then without dollarization, given where Argentina is right now. So dollarization can be the regime that opens the door to any other monetary regime you may want that today is not possible. It's going to take time, of course, because the amount of credibility that Argentina needs to build is very significant. Daydreaming to think that all of a sudden you can have the credibility and the robustness to have these monetary regimes like we want government.
Now it's going to take years. So that's part of reality. But dollarization, I see it as a potential transition to something else, not necessarily an end game. That's the main reason why I'm thinking if I were to propose this in Argentina, I would say, okay, you can start with El Salvador and I will input in the law this provision, but it doesn't have to be that way.
But that's the reason why for Argentina, we feel more comfortable if the how did it is for the government to do these things again. One of the assumptions that is behind the design of the proposal is that Argentina will sooner or later elect again Like many times in the past, a populist government, so we need to have a design that will be as robust as possible to a new populist government taking place.
And so that's why we're trying to think of all these institutional protections to the monetary regime.
Rasheed: So before you were explaining, let's say, after the threshold is reached, you want to get rid of all the pesos, out of circulation. How do you go about doing that part?
Nicolás: The central bank or the treasury or whoever is at that moment still present will have to execute a plan to reach out to the market and say, okay, by this time you have to deliver me the pesos and I will give you in exchange the equivalent amount of dollars.
Rasheed: By the way, when you mention they've closed the central bank, what do you mean by that point? Because of course, the central bank does other functions besides monetary policy.
Nicolás: The central bank is liquidated, and has to be shut down. So the functions that the central bank is doing, other than issuing currency, of course, because you're dollarizing, but those functions can be relocated to other agencies, financial regulation that can be done by a new or existing financial regulatory agency.
It doesn't have to be done by the central bank. Clearing, you can have a clearing house without a central bank. So all the other things the central bank does, you can relocate them into other agencies. You can use that closing of the central bank to create a new professional independent from the government agency if you want as well.
Rasheed: Which happens in Panama?
Nicolás: Yes.
Rasheed: Panama, the banking provision office does the banking regulations, the clearing house, it's a consortium of the, there's one state bank plus private banks that run the clearing house in Panama. So yes, there are ways to do it without a central bank.
Nicolás: Exactly, and something that you can do that many people in Argentina don't do is to spend a few minutes on Google and find out how this happens in countries that are dollarized.
We can go and see, we don't have to just try to imagine this. Okay, an important point I wanted to mention is that if you go El Salvador way, where you say the pesos don't lose validity, you don't need a lot of dollars to dollarize. Because you are changing which currency has a legal tender status, and you are not obligating yourself to make that change.
Okay, you have to fix the rate. Again, you're doing at the equilibrium value, so that won't be a problem for you as a central bank, but you don't necessarily have the money to say, I'm going to change all this currency today. So to dollarize is cheaper than it seems. The third component is, okay, what do you do with the central bank liability?
So let me give you just a little background so everyone understands what these liabilities are and why the central bank has them. Because it's a little odd unless you know what's going on in Argentina. So a typical central bank, if they want to contract or withdraw some money from the market, a typical central bank will sell, in an open market operation, some financial assets, like treasury bonds.
So I'm the central bank. I have bonds issued by the treasury. I need to withdraw some money from the market. I'm going to go to the banks and say, okay, I want to take away a hundred million pesos. I'm selling these bonds. Who is buying? You buy from me. I give you these bonds. As you give me the pesos, I manage how much money is out there in the market.
The central bank in Argentina, and the treasury bonds they have, are non-transferable. So legally, those bonds cannot be sold to the market. So if I'm the central bank in Argentina, and I need to take money away from the market because inflation is running high, I cannot sell treasury bonds. I don't have dollars to sell.
I don't have assets to sell. So what I'm going to do is issue my bonds and sell you that. Central bank issues short-term debt and instead of selling you a treasury bond, I'm going to sell you my bonds. Here's my bond. You bank, give me the pesos. So the central bank started to accumulate a large amount of short-term liabilities denominated in pesos.
And this created dangerous expectations because like any bond, sooner or later, they're going to be paid off. And these are short run. So you find the bond holder and I don't want to roll over these bonds. I'm going to say to the central bank, pay me in pesos, but inflation is high in Argentina.
I don't want to save in pesos. I want to save in dollars. So as soon as you give me the pesos, I turn around and I go to the exchange market and buy dollars, and boom, you have a currency crisis and a spike in inflation, even higher. This happened during the Macri government. Now these bonds, which are called 'letras de liquidez', or liquidity notes, I think they were like three months maturity or something like that, but they are backing bank deposits.
And remember, the bank deposits are transactional. So if I default on these bonds in any way, if I do like a mandatory swap or something like that, then you as a business manager, you have a problem because all that money in the bank, which is backed by these bonds, now I cannot use them because that bond is defaulted.
I don't have the money to pay wages and my suppliers and so on. This is a very delicate situation. You cannot set the banking system down and freeze the transaction payments. So you have to deal with these liabilities. The central bank in Argentina is technically speaking bankrupt, which means if you want to dollarize and liquidate, you have a problem.
If you shut down the central bank, you have a shortfall of dollars, not a surplus. So how do you fix that? How do you input more resources into the central bank? One way is to say, who is the owner? If you want to the Argentine central bank, that's the government. So the government can issue sovereign debt, collect dollars, and give the dollars to the central bank.
That's easy to understand. It's easy to see. It's transparent. It's not feasible because Argentina cannot issue debt.
Rasheed: And they can't issue debt because no one wants to buy the debt, correct?
Nicolás: Yeah, who's going to buy Argentine bonds? Unless the market conditions change, and for some reason, they want Argentine bonds right now, this is not an option.
Or at least it wasn't an option when we were working on the proposal, right? We need to find another way. So what's another way? Instead of issuing sovereign debt, I'm going to sell, I'm the government, I'm going to sell Assets I have. So I have these investment portfolios, I have stuff, I can sell it in the market, get the proceeds, send that to the bank.
This is a fire sale, and the market size in Argentina is not large enough to absorb a sale like this. So you're going to have a price problem. You can disrupt your secondary market. Again, not feasible and expensive.
Rasheed: So what would you be selling as the government?
Nicolás: What will be one of the things that can be sold is a few years back, the government nationalized all the private retirement and pension funds, all your like, if you're in the U.S. All your 401ks, all that stuff, all your retirement and pension fund investment, equity, stock bonds, and so on, all that became one big portfolio and office in the government, the office that manages the public pension program.
So one option is to get that, sell it in the market, get the proceeds, and Give the dollars to the central bank. This is costly because it's a fire sale. You're going to be selling at a price that is subpar and it's sold, it's gone. So it's not doable because the market cannot absorb that size of a shifting supply of financial instruments.
This leaves us with what is proposed in the book and in our blog, which is a structured financial solution that requires some financial engineering and thinking. This has an upside. It allows you to capture an upside in the valuation of Argentine instruments, there is no loss for the private or government sector. The downside is that it's difficult to understand.
It's a complicated process. This is where we find most of the issues when we try to explain this, but I'm going to explain it in the easiest way I can for everyone to get an idea of how this works. Conceptually speaking, before I go into the steps, you have these central bank special liabilities.
You can dollarize them in two ways. One is, which is what most people think is a default. You have to go and buy them. I'm going to buy all those bonds and give you the dollars today. Like you dollarize on the spot. The other way is to treat them as what they are. They are bonds. So you pay them off in a sinking fund scheme for a longer period.
You don't have to pay them off today. So how do we do that? I'm going to divide this into steps to separate conceptually how this works. If you execute something like this, everything may happen together or the order may change. But conceptually speaking, I'm going to separate this into like steps. So the first step is we need to get these bonds that the central bank has issued by the treasury that are non-transferable. So the treasury is going to collect them and it's going to transform them. It's going to swap them for sovereign bonds issued under New York law that for any intent and purpose can be traded in the market. The amount of that swap is the same.
So if the central bank has a hundred dollars in these non-transferable bonds, the government says give me those hundred dollars bonds and I issue new hundred dollar bonds. So the amount of debt remains the same.
Rasheed: Let me pause you a bit there because I want to clarify. Why exactly were the bonds sent to banks in Argentina non-transferable in the first place?
Nicolás: Why they were issued as non-transferable?
Rasheed: Yes.
Nicolás: I think a reason was when these bonds mature, the central bank has them. So the treasury has the option to, instead of paying them, just run them over.
But if they're sold to the bank they say, no, give me the money.
Rasheed: And was that a recent, relatively recent process, or is that a long-term Argentina system?
Nicolás: No, this comes after the 2001 crisis, if I remember correctly. Another reason is that, again, Argentina has a small financial market. So if you have the central bank going to the market and selling these bonds, the price of the bond will fall, the interest rate will go up, and now the treasury has a higher cost on its debt.
So it also has to do with the size of the market in which you will be selling these bonds. The first thing that the Treasury has to do is take these bonds and transform them into standard tradable bonds issued under New York law. These bonds will be transferred into a trust located outside Argentine jurisdiction.
We call this the Monetary Stabilization Fund. I take these bonds, I transform them into tradable bonds. I don't sell them in the market. This is important. These bonds never go to the market. You get them and you put them in the assets of this trust. The other thing is that It's going to go into those assets, and I'll explain in a few minutes the reasons for this.
There are other contributions that the treasury can give to this fund. I'm going to give a few examples. They may be other ones, may not be this one. These are examples to capture the idea. The portfolio of investments I mentioned from the nationalization of the pension and retirement funds, move them to this trust.
And this portfolio is going to create a payment in dividends, coupons, and so on. Another thing that you can transfer is all these export taxes that you as an agricultural producer, had to pay to the treasury. A part of that, you give it to this trust, and the remaining, you give it to the treasury.
So if I produce, I don't know, wheat in Argentina and I'm going to sell it to the rest of the world and I need to pay $100 in taxes, I'm going to give, I don't know, $20 to the trust, $80 to the government because it won't be realistic, I think, to assume that the new government will be able to eliminate those taxes overnight because the government still needs some dollars.
Another thing that a government can do is if I'm going to sell and get proceeds from the 5G network for mobile phones, those proceeds, I can just send to their trust. By doing this, you diversify with some limits, but you diversify to some extent the source of the cash flow in this trust. Because once you move those bonds there, this trust depends on the government continuing to pay those bonds.
But the coupons and dividends from the portfolio investment are coming from other governments and the private sector, so it doesn't come from Argentina. The export taxes come from agricultural producers and other exporters, so it's not the Argentine government. So you diversify to whatever limit you can and you want the source of that cash flow.
This is on the asset side of this trust, international jurisdiction outside Argentine government control. Now we have the liability side of the central bank with these central bank liabilities. It's a similar idea. This is short-term debt. So it's going to be, that the central bank has been liquidated. We need to change the issuer.
The issuer is going to be the trust, and the trust is going to replace these peso short-term notes with short-term dollar notes, like commercial paper. So I'm the trust, and I work at the computer. My assets, which include the bonds, the portfolio investment, the contribution from exporters, and whatever I have there, create my cash flow.
So I collect 20. I turn around and say, I'm going to pay off 20 on the now dollarized if you want, liabilities held by, that were issued by the central bank, and I'm going to roll over the remaining. Next year, I get another 20, I turn around to the market, boom, 20, and I keep canceling it down as a sinking fund until there are no more central bank liabilities outstanding.
When that happens, by then, if you are serious about dollarizing, doing reforms, and you are reducing the Argentine risk, the market value of those assets has to increase because your discount rate is going down. So once you've paid off all these liabilities you pay with a cash flow, not by selling assets to the market.
You have all those bonds, you have all those equities, all that stuff, the trust gets liquidated and all the assets go back to the government. And it gives you two things. One is you created a very big production in Argentine debt without having to default, right? Because those treasury bonds go back to the issuer they get canceled and you recover that portfolio that was maybe being misused, but it was originally set up. Sitting, doing something, whatever that was at this retirement office in the government. So that goes back there if you want, maybe you want to send it somewhere else, but it can go back to its original location and then your dollarization process is finished.
Now, if we are following this situation, as I mentioned before, when you asked me about why these funds were non-transferable, and I say one reason, as the government doesn't have to pay them, they can't roll them over, but now these new bonds, the government has to pay them. That's how you're dollarizing. Dollarization is not free.
This is how you produce these dollars to cancel this debt, you have to pay your debt. So now the government needs to pay those. And someone will say, well, the Argentine government has a very delicate fiscal situation, and now you're having to make them pay all this extra debt? That's not going to work. By doing this, you open yourself to the option to manage how that cash flow is going to look.
So you can do a couple of things. One is when you transform the non-transferable bonds to the new bonds, you can say, but now the first payment is going to be in one or two years. So I give myself a grace period to get my balance, fix my fiscal situation, and be able to deal with this. What do you do in between?
You're getting money from the exporters, the portfolio you move there. So you're getting some cash flow in the short run. The other thing you can do is you can extend the duration. These bonds, instead of maturing in five years, I'm going to make them mature in seven years. So you have a way to calibrate that cash flow so that the treasury can deal with it.
For the public, dollarization is almost like "Oh, the US dollar is legal tender, my bank deposits are dollarized, I have pesos cash but they are fixed at the dollarization rate against the dollar, prices are denominated in dollars, as a consumer, as a public, I'm already dollarized". Even if, for the government, the whole process may take several years, it doesn't matter, that's happening behind the scenes.
But once you announce dollarization, you make the change.
Rasheed: And how long would you think that think and fund trust mechanism would take to reduce the past budget of the central bank?
Nicolás: Ideally, I would like to see the process complete before the end of a presidential term. So you don't have to go through the risk of the new government trying to mess up with this in any way they can figure out.
But maybe that's not doable and maybe you have to postpone it. So how long it's going to take, will depend on, when you dollarize, and how many central bank liabilities you have outstanding. Two, it will depend on how much you can have the Treasury manage these payments that we have to make to the new Treasury.
It will depend on how many other assets you want to send to the trust. It depends on a lot of variables, but the point is that you have the flexibility to manage that. It's not that if you cannot do it in four years, then you cannot do it. All right. I'm giving you an option that the four years is too short for you can do it in six years, seven years, or how long you want.
Rasheed: And in your idea, who would be the managers of this kind of offshore trust?
Nicolás: It will be an international financial institution working outside Argentine jurisdiction with a very clear mandate. You work like a calculator. Every dollar that you produce has to be used to cancel off debt.
It's like a rule. There is no discretion here, but you need a manager to make that rule happen. And that's it. And once the last dollar is paid off, it gets liquidated and everything goes back to the treasury.
Rasheed: So I suppose in standard financial markets, this is a pretty standard idea, standard plan, using special purpose vehicles to do similar things.
But I can see obviously why in a context of dollarization public policy, is typically not discussed in those contexts.
Nicolas: I'm sorry, you mean that usually when you hear about dollarization, this discussion is typically not there?
Rasheed: No, I'm saying this part of your plan is a fairly standard financial engineering vehicle that many companies and large banks use, but in terms of public policy dollarization, this is not ever discussed in a sophisticated way.
Nicolás: Yes, that's a very important point. This part of the proposal, if you have some familiarity with international financial markets, there's nothing strange here. Maybe the novelties that are being used in a dollarization proposal, but having these asset-backed commercial papers, there's nothing out of the ordinary here.
This is an excess collateral because you have a high exposure to Argentine risk and that excess collateral, you can use it to collect dollars to send, as I was saying before, to Argentina, if you need cash, for instance. You can do all these financial enhancements and credit enhancements and different arrangements to improve even further the risk exposure of this to the extent you can. But yes, you can use standard international financial instruments. So why this is not much of a talk when you hear about dollarization? I think there may be two or three reasons. One is in cases of countries that dollarize, they didn't have to deal with this problem of central bank liabilities. They didn't need to come up with something like this. Another reason is that financial markets in Argentina are not as complex and developed as international markets, so many of these instruments are uncommon for many economists who work in Argentina, so they're not used to thinking about this.
Not that they cannot understand, it's the common tools I'm thinking about how I do this in a place like Argentina. And so it can be confusing. So one of the issues we had was that many critics were thinking that we were proposing to sell the treasury bonds in the market. And if you sell all those bonds, you're going to make the price go down.
No, these bonds never go to the market. It's just they're backing in the sense that they produce the cash flow to pay off those debts. They are confused like, "Oh, you're going to use the bond as collateral". No, not exactly as a collateral. This is like a different vehicle. So those kinds of confusions happen.
But then it leads you to think this is not doable or is problematic, but that's not exactly how this works. Another reason is that even if dollarization is a topic of much more interest in emerging economies than, I don't know, the U.S., European countries, and so on, it's still a topic not very profoundly studied by many economists.
Most of the approaches to dollarization are, "Okay, How do I put this into a standard model? What happens is the exchange rate now, if you are dollarized and what happens with shocks and so on". However, there is not much focus on the implementation part. It's, "Oh, I need to change the currency base into dollars. What's the exchange rate of that?"
Yeah, that's a very simple calculation. And it's as simple as it is misleading because as we were talking, you don't need to buy the pesos today. Depending on how you dollarize, you don't have to buy those pesos. You know, the El Salvador way, all that simple calculation that steps aside from all these considerations is what most economists typically think of.
That's our framework.
Rasheed: That reminds me of this paper that was published by these three MIT Argentine economists. I'm sure you're familiar with it. It was called "Dollarization Dynamics" by Caravello, Werning, I think, and Bruera. I think those were their names. And they made this dollar shortage point in Argentina. You can't do it. It would cause this big. The sudden stop in the economy and so on. And the model, they, as you said, you, there's just a very basic static model that didn't give any indication of their analysis of how dollar rates have happened previously in other countries.
Nicolás: We know that paper, of course, and Emilio and I, have a working paper commenting on them.
One of the things is how they treat the dollar shortage. And again, you have ways to deal with that. They did not comment to point out that you can set an exchange rate without having to have the dollars today. And I'm not making that up in my mind. That's how it happened in the real world.
The other interesting thing is that if you compare the projections of that paper with Ecuador when Ecuador dollarizes, they depreciate their exchange rate. The predictions of the model are backward to what happened in Ecuador. But there are no discussions in this paper, as far as I remember at least, of these are my model predictions. Let's look at the real case, where something more or less similar at least happened, does the prediction match the model or not, and why?
And there is no discussion of Ecuador, and that's one of the things we bring up. I think one of the reasons why that backward prediction happens is one of the confusions around dollarization. A typical way that you treat dollarization in these models is as a hard peg, like a really strong fixed exchange rate.
And I think that's wrong in this sense. Of course, you have some overlap between a fixed exchange regime and dollarization, but dollarization is also an institutional change. It's not just a policy change. One of the key changes is now you have a policy whose existence does not depend only at least on domestic politics.
That's a very deep institutional change and as such it's going to change the behavior of economic actors. It changes expectations. It changed the deep parameters like sometimes you economists sometimes talk about. And therefore I cannot just take the pre-dollarization model and forecast that into a fixed exchange rate regime because it is not a fixed exchange regime.
You have new parameters here. And I think that's one of the reasons why some of these estimations are off-mark.
Rasheed: So one of the other very common objections to dollarization in Argentina, in particular, is the constitutional objection, if I use that term, in the sense that this claim that article 75 of the Argentinian constitution prohibits, it doesn't explicitly use those terms, but it's the interpretation that it prohibits the idea that dollarization could legally happen in Argentina.
Do you see that as true?
Nicolás: That's a common concern. It became more prominent after one of the Argentine Supreme Court judges gave a similar interpretation. For me, it was a little odd because typically, if a judge gives an opinion before a case, then he has to recuse himself because he's given in advance how he may rule, right?
So I was surprised to see him talking about this. He also mentions a very superficial, simplistic way of how to implement dollarization. So let me first give you what I see Constitutionalists in Argentina see in this article you mentioned. Some of them will say, "Yes, this will be constitutional", but a very large number of other Constitutionalists say, "No, that's not what this article means".
I agree with this second group. I'll explain why, but then I will come back to why even if it's unconstitutional, how you can dollarize. So what this article is doing is, first, it's giving the right, not obligation, to the government to issue currency. Two, the article gives the government a mandate to make sure that the country has a currency.
It doesn't have to be the national currency. And I think in Spanish it's something like “Hacer sellar moneda”, so you have to have currency. It doesn't say it has to be your currency. Another historical component is that the time this type of article, which is not only present in the Argentine constitution, is common around Latin America.
These articles are from before there were central banks. So the whole point is you are creating a new country in this region. And if it weren't for these dependencies, you as a government, need to make sure there is money here that we can use, whatever that money is. That's more aligned with the interpretation of the constitutional lawyers that say, "If I put this in the table if I read that it says instead of an obligation, that your mind it is to make sure there is a currency, doesn't have to be your government currency, you can dollarize".
And even before going into this debate, when I read that article, that was my reading as well. Oh, this is what you're saying. And it makes sense, right? When this was written, this was years before there was any kind of central bank. There were different currencies in Argentina. So one way the government can fulfill the mandate is by saying the currency that no one wants, the dollar people want is here. We are fulfilling the mandate of delivering to the country sound money or better money than we have. Now let's say that this goes to the Supreme Court and there's a ruling. No, it's unconstitutional. Argentine government has to issue its own currency. You can still dollarize. Let me explain how you do that.
It has to do with the El Salvador way. That's one way. You leave the peso in circulation. If you cannot liquidate the central bank, you minimize it the most you can. I don't know. Let's say, the pesos are there, but you also give that we know it's possible because this happened in Argentina before. You give the U.S., you let contracts be in dollars, you give the dollar legal tender status. And if the market moves to the U.S. dollar, what are you going to do? That's what happened in El Salvador. In El Salvador, the colones went away because the public moved to the dollar. But legally speaking, as the government, I'm providing the peso.
But I cannot force them to get it, right? Another way, I'm gonna shut down the central bank, I'm gonna issue this moneda al Argentino, and I'm gonna put it in a safety box after seven keys of locks underground. That's my issuance. Legally speaking, I issue the Argentine currency. It's legal tender, but I'm sorry, no one has it.
I'm giving an extreme example, but Ecuador is something like that. So even if there are constitutional constraints to this, you have a way to still navigate the dollarization. So even in the most complicated scenario, this doesn't mean you cannot dollarize. It just means you dollarize differently.
Rasheed: Didn't Ecuador do something similar to your extreme scenario?
Nicolás: I think they issued a kind of commemorative coin. I don't remember the details, but I think they did something like that. Putting it in a safety box underground I kind of made that up a little bit. But the point is the concept.
I can issue something that has all the legal requirements of being the national currency, but it doesn't have to be in circulation. And if I put it in circulation and the market doesn't want it and send it back to me, how is that unconstitutional?
Rasheed: Now, the expectation from many people when Milei won the election was that a version of your plan would likely have been implemented, but that was not the case. I don't know if you have anything to mention, but why do you think this directional change was, if it was even a directional change, Milei still says the lower edition is on the table, but there's no indication really that it's going to happen anytime soon.
Nicolás: Before the elections, there were three possible scenarios. One scenario is that you take office and you dollarize as soon as you can. That would be my preference for several reasons. Another scenario is that you dollarize later because you want, for instance, to balance your budget before dollarizing.
And another scenario is that you don't dollarize. You just try to keep the peso alive. When he mentions that he wants Emilio Campo to be the head, the next and last president of the central bank, the expectation is, okay, he's going to dollarize sooner instead of later because that's what the proposal and that's what he's appointed Emilio for and so on.
As we know today, that did not happen. So now we have this new policy basically by Caputo and Bausili. Caputo is the Minister of Economia, Bausili is the central bank president. And if you look at what they are doing that's consistent with saying they want to dollarize, but later, but it's also consistent with trying to keep the peso alive.
So now it's up to everyone to decide, what do I believe? Does he want to dollarize or is dollarization just a political campaign to attract votes and support? It's hard to know for sure. It depends on how much I feel I believe him. So I want to make that clear, right? Some people strongly believe he's going to dollarize.
Some people have more doubts. I'm more like, I know his actions are consistent with both, so there is rational room to have these doubts. So the issue with waiting to dollarize is that the scenario that's in my mind is the most likely to play out, assuming Argentina dollarizes, is that one similar to Ecuador in the sense that Argentina dollarizes because there is no way out of a very serious crisis.
The country has no idea what to do. They throw the towel, they dollarize however they can, and they decide how to dollarize some weekend at midnight, a lot of improvisation, and a lot of errors. And that's why we started to work on this book as early as 2020, because the scenario was Argentina, the economic situation is pushing Argentina to dollarize and it's going to be an improvisation mess.
Let's have something written down that can be used as a guideline. It wasn't expected when we started with the project that Milei would say, I want to dollarize and I want to do it following this book, and then we had to keep working on the proposal and refine it and so on. The risk of waiting is that in between, things can go wrong.
What if, because of this pushback that Milei is having in Congress, the market thinks he's not going to be able to balance the budget? Therefore, he's not going to be able to cut down on inflation. Therefore, I want to move to the dollar today because I don't believe this crawling peg that he announced is going to be sustainable.
And now you have to dollarize in a much worse situation than you had, as bad as it was at the beginning of the government. Because you lose time, and you lose that you need to dollarize political capital. All these reforms that he wants to do, take time to implement, and they take time to produce an economic effect for the public to connect to that.
He wants to balance the budget by the end of the year. That's one year. A lot of things can go wrong in one year. And do you have one year? Because before you know it, you will have to get ready for midterm elections. If you dollarize, you produce an institutional and an immediate shock to expectations.
Inflation starts to go quickly and you have the political capital because Argentines want the dollars, right? I'm not trying to say, give me the pesos that you don't want and I'm forcing you to use the dollar you don't want. It's the other way, right? You want the dollar, here you go. So you have the political power and the political latitude to implement the other reforms that you have to push forward, like labor reforms, trade reforms, and fiscal reforms.
But now you are dollarized, so you cannot throw under the carpet your labor market rigidities with inflation and reducing real wages. No, now you have to do the reform, you have to move forward. And that's the reason why if you want to do long-lasting reforms, you start with the reforms that are more difficult to reverse so that your incentive is to keep moving forward.
If you start with the labor reform, you undo the reform next month. Argentina changes its laws like nothing. It's not credible, right? And that's an issue with these laws, the omnibus law and the creed that Milei is trying to pass. Okay, but how long is this going to last? If the next government can turn it around just as easily?
What's the credibility, the long-run credibility of these reforms? Dollarization helps you to build that because now it's not to your benefit to walk back in those reforms. Dollarization is still on the table, either because Milei wants to dollarize. Maybe he will surprise us tomorrow and announce dollarization, who knows?
But maybe he still wants to do it, so it's on the table. There was a spike of interest, I think, in the last few days about this. And it's still on the table because even if what he's doing in the economic policy area improves things for some time, if this is not a real long-term solution, two, three years down the road.
Four years, five years, we'll still be talking again about dollarization. Argentina almost dollarized in the late 1990s, it was very close. It didn't, here we are again. So when we talk about dollarization, or when I talk about dollarization, I'm not thinking about a policy that will last for a few years.
I'm thinking about a long-term solution. If you tell me we do this policy and then we talk about dollarization again in five years, that's my point. I don't want a policy that only lasts five years. That's nothing. It's something that has a much longer time horizon. I'm not thinking about the short term. I think like a long-term solution.
Rasheed: What would it look like if, for example, dollarization was announced, but what would it look like if it was not being done properly?
Nicolás: It depends on what that weakness would look like. You can have issues like Correa, you dollarize, and then you elect a new Kirchnerista. And he finds a way to seize deposits.
He finds a way to, I don't know, monetize some of his deficit. It will depend on how that weakness looks. But when I think of Argentina, we're not talking about the dollar rise in Chile or Peru, right? We're talking about dollarizing Argentina. What Argentina needs the most is a strong, credible institutional framework.
And if you can credibly provide price stability. For any time on the horizon you can think of, that's a huge benefit. 2008 Correa is in government in Ecuador, a strong populist. He defaulted the debt, sovereign debt, and we had a 2008 crisis, or 2008, 2009. The Ecuadorian risk premium went up, right?
You defaulted in the 2008 crisis, and the prime risk of Ecuador's debt went up a lot. The private sector interest rates remain flat. The access to credit in the private sector remained the same. If you are dollarized and you mess up fiscally, you as a government, pay the cost, but not the private sector. The private sector gets isolated to some extent, an important extent, from government imbalances.
Rasheed: I think that covers all of my questions. Was there any particular point you want to emphasize a bit more or it sounds like your answers?
Nicolás: I can't think right now. I think we talk about a lot of stuff. Dollarization is still on the table. It's still being discussed. I know most of our writings are in Spanish, but I translated many of my Spanish postings to English in my blog, so you can find some of that there.
I have a post where I summarize the steps that we talk about how you dollarize, so you can go back and read that as well. It's a very exciting topic. If Argentina dollarizes, It's probably going to be the largest economy to do that, at least in the region. And who knows, it may produce a domino effect in the region and other areas for countries to just connect themselves to the world reserve currency.
That would be a major shift in economics.
Rasheed: Nicolas, thank you so much for joining me on the podcast today.
Nicolás: Thank you for the invitation.
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