Nicolas Cachanosky on Dollarization in Argentina

As hyperinflation and other macroeconomic concerns continue plague Argentina, committing to a policy of dollarization may offer a much needed remedy.

Nicolas Cachanosky is an associate professor of economics at the University of Texas at El Paso, and he, along with Emilio Ocampo, are the authors of a recent book titled, *Dollarization: A Solution for Argentina.* Nicolas joins Macro Musings to talk about the potential dollarization of Argentina, including what it would require and mean for the country. Specifically, David and Nicolas also discuss Argentina’s hyperinflationary experience, the three necessary steps for dollarization, the differences between dollarization and currency boards, and a lot more.

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Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Nicolas, welcome to the show.

Nicolas Cachanosky: Hi, David. Welcome, and thank you for your invitation.

Beckworth: Oh, glad to have you on. This is long overdue. I've known you for some time, but I'm glad to get you on here. Something that's near and dear to your heart, dollarization in Argentina, it's a front page story right now, and you happen to have written a lot of articles. This book I just mentioned came out about the same time the president-elect suggested it, so your paths have crossed, or at least your co-author's path have crossed with the president-elect. Before we get into dollarization and all of that, though, let's talk about Argentina itself and maybe why people there are talking about dollarization. You're from Argentina originally, correct?

Cachanosky: Correct. I was born and raised in Buenos Aires. I moved to the US in 2009, as a 20-something-year-old, so I have spent a lot of time in Buenos Aires living [through the] Argentina crisis myself.

Beckworth: You have lived it firsthand. I know you have family back there and you travel and visit a lot, but in preparing for the show, I just came up with a few facts about the economy and the country. You have a population of about 46 million. If you look at GDP in purchasing power parity dollars, it's about $1.2 trillion. That's PPP dollars. The unemployment rate is getting close to 8%, 7.5% to 8%. Inflation, 140% plus, even if you look at core inflation, it's over 100%. So we're having hyperinflation in an economy, that's a good-size economy, second largest economy in South America. How does this really feel on the ground? If you're an Argentine living in Argentina, you're in a big economy, Buenos Aires is a very big, affluent city, what does inflation mean to you, the hyperinflation you're going through?

The Hyperinflationary Experience in Argentina

Cachanosky: One of the problems is that, this is not new for Argentina. If you look at the inflation rate between 1945 and today, and you take what would be the yearly inflation rate, the average for that period, that's 60%.

Beckworth: Wow.

Cachanosky: You have a country that is getting close to 100 years, with 60% inflation per year, every year; very high, very volatile. That's the reason why dollarization is a topic in Argentina. I would like to mention this before I forget, the reason why we see this conversation today is because, besides what Milei wants to do, it's because of the Argentine economic conditions. It's so bad, that people talk about dollarization, whether or not Milei wants to do it. If you're in Argentina, you have, as you mentioned, very high inflation, one of the highest inflations in the world, but you also have a very complicated context.

Cachanosky: In real terms, the Argentine economy has been stagnated for more than 10 years, 11 or 12 by now. Inflation has been high and rising since 2007. Put yourself in the shoes of the young population, and what you have is a decade, or maybe a little more, with no growth and rising inflation, and no easy way out that you can see in the near future. I haven't checked the numbers, but the conversation is that there is more people living in Argentina today than there was with the 2001 crisis, which was a very big crisis in Argentina. Because the economic situation is-- it doesn't give you any hope, right? If you're a young people in Argentina, you look at the future, there is no hope, and you do it out of fear.

Beckworth: Going back to the 2001 episode, and we'll touch on it later when we talk about currency boards in Argentina, but that 2001 episode itself was a response to earlier periods of hyperinflation, and it brought in the hard peg, the currency board. I remember reading about those earlier hyperinflation periods. You would go into a restaurant in Argentina, Buenos Aires, for example, and you'd sit down and you wouldn't know how much your meal would cost when you left. The food manager, the restaurant manager would be in the back listening to the radio as prices went up, and by the time you went out, it could be double, triple what you'd expected. Is that something that's happening now?

Cachanosky: I don't know if it's happening now, but I'm starting to hear stories about, you walk into a grocery store, and by the time you get out, you see some prices changing. Now, you're correct, Argentina had a hyperinflation case in the late 1980s, early 1990s. The way out of that was a currency board during the 1990s, and Argentina is the only country, or maybe one of the only few countries, that had experienced hyperinflation without having to go through a war, or something like that, like a self-inflicted hyperinflation without, “I need to pay for water,” or something like that.

Cachanosky: If you look at the monetary situation today, and we're going to probably talk about the central bank liabilities that the Argentine central bank has today, that's a similar scenario than the one you had before the hyperinflation in the 1980s, and it adds to the problem. As people say in Argentina, we don't only have high inflation already, we may have hyperinflation down the road if we don't do something serious quickly. It's a very delicate situation, and the new government-- Now, we know that Milei won the election, but before we had a president-elect, whoever was going to be the next president, that person would have a very challenging problem ahead.

Beckworth: That's interesting. So, people in Argentina are cognizant, very aware that the high inflation they're experiencing now is not the end of the story. It may get even worse, like it was in the 1980s and 1990s. So, people, they want something to be done about that, make sure they don't get to really big hyperinflation. The other point you mentioned earlier was that even if President Milei had not been elected to office, other people were talking about dollarization as a potential solution. He just happens to be someone who's sensational. He's got the big hair, he's got a personality. He's a good social media person to see and to watch and to listen to. He's very passionate about what he believes. But you’re saying that, look, dollarization was already being considered. It's nothing new, and people are concerned about hyperinflation really taking off. Even though we're at 140%, it could get worse.

The Path to Dollarization

Cachanosky: Dollarization is not a new topic in Argentina. It has been around for many years. At the turn of the century, dollarization was a big topic, a decent topic of research. We have Ecuador dollarizing. We have El Salvador dollarizing. There was conversation about Mexico dollarizing. Argentina almost dollarized in the late 1990s. It didn't happen, but it was quite close. Some economies have been advocating for dollarization before the late 1990s. When you look at this new scenario, for all the things you are talking about, dollarization came up on the surface. Another reason for that is that if you remember that Argentina has, on average, 60% inflation every year, you don't save in pesos. You save in dollars.

Cachanosky: Argentina is, today, already de facto dollarized. The idea of dollarization is not to go to the Argentine and say, “I want to take away the pesos from you that you want, and I want to give you the US dollars that you do not want.” It's the exact opposite. You don't want to hold pesos. You don't have to. You want to hold dollars? There you go. The idea is to go from a de facto dollarization to a de jure dollarization. The reason I worked on this book that you mentioned, with Emilio Ocampo, is we started to work on this and do research on dollarization in the fall of 2020. I remember, I was spending my sabbatical at Texas State University while handling COVID restrictions and all of these issues. Milei wasn't even in the picture as a presidential candidate yet.

Cachanosky: So why are we talking about this book? The reason was that we were looking at the Argentine economy, and our sense was, the way this is going on, the way the Argentine economy is going to unfold is going to push the country to have to dollarize. Because we tried everything, and nothing works. If you want to do something serious, credible, and lasting, they will have to consider dollarization. And our concern back then, or one of the concerns we had was, well, if Argentina is going to dollarize in that situation, looking at the cliff, everything's about to blow up and you have to dollarize, we're going to have the Argentine Congress designing dollarization at midnight, at the last moment, with a lot of improvisation and a lot of mistakes.

Cachanosky: When that situation materializes, let's have a plan that we have thought and studied and shared and revised and discussed, so that you have a blueprint, a guide of where to go, if this happens. We weren't planning on having this book become the central piece of an actual president deciding, “I want to dollarize,” following this book. That wasn't part of the original plan. The plan was, if Argentina dollarizes at the last moment, with improvisation, let's minimize those mistakes and let's have something sure to present in that case.

Beckworth: So you were writing this book before president-elect Milei was even on the scene talking about dollarization. Serendipity kicked in, and he found your book and said, “this is the plan I want to follow.” You were thinking about this long before, and as you mentioned, dollarization is something that's unofficially taken hold for many people. In fact, one of the points you bring out in your articles we're going to talk about later, is that dollarization really isn't about dollarizing the private sector, it's about dollarizing the public sector. It's the state, the central bank, that needs to be dollarized, because households, as you've just noted, they hold a lot of dollars, some of them abroad, but they already use or do transactions in dollars. It's an interesting story, great timing for your book, even though you weren't thinking this would actually be timed with a new president who was sympathetic to it. So you have a book with Emilio Ocampo, and again, the title is, Dollarization: A Solution for Argentina. You also have a Substack. What's the name of your Substack?

Cachanosky: Economic Order. So what happened is, we started working on the book in the fall of 2020. I will say that I had a very short, brief article on the case for Argentine dollarization. I worked with Adrián Ravier, another Argentine economist, that came out in 2014. So, the topic has been around for a long time. Now, when we finally finished writing this book… broadly speaking, it has three parts. The first part is the review of the Argentine monetary history. The sense you get after you go through Argentine economic history is like, “this is a mess, there is no solution to this.” You have to start over again.

Cachanosky: The second part of the book is, well, let's, step aside from the blackboard or the whiteboard and let's look at real-world cases of dollarization; how it actually happened, what happened afterwards, how they did it, right? Because now, we have 20 years of Ecuador's and El Salvador's experience, that when we were doing dollarization research at the turn of the century, we did not have. Now, we do have that, so let's go and look. We can also draw some lessons from the Eurozone, even if it's not exactly the same, but there's some things that you can learn from that.

Cachanosky: The third part is, okay, if Argentina has to dollarize, how will we do it? This is something important that sometimes gets missed. There are different ways to dollarize. Depending how you decide to dollarize, the dollarization process can take more time, less time, can require more dollars, less dollars. There are different ways to approach this and you need to design a dollarization strategy that matches the needs and situation of the country you're trying to dollarize. So the third part of the book is, okay, for the case of Argentina, how we go about that?

Cachanosky: Now, the book is about to come out in 2022. The week before the book was about to hit the shelves in Argentina, Milei publicly says, “if I'm elected president, I'm going to dollarize.” It was pure chance that those two events happened one week apart. Now, when he started to talk about how he wants to dollarize, we had some concerns about what he wanted to do. I'm in the US, I'm in El Paso, Texas, I never talked with Milei actually, but I know that my co-author Emilio Ocampo did. Eventually, he got the idea that, what we were saying in the book was more [sensible], made more sense than his proposal. So, at some point he publicly said, “well, I want to dollarize following the book by Ocampo and Cachanosky.” Again, we didn't write the book for one candidate. We wrote the book and we presented this to almost all of the presidential candidates and their teams running for president. The idea was, whoever wants to do this, if anyone wants to do this, this is our suggestion.

Beckworth: Yes, and just to stress this one more time, your book was a very pragmatic exercise on how to dollarize, because from what you could see, nothing else had worked, nothing else will work, and the country would be at a cliff, and Congress, Parliament would just forcibly do dollarization at some point. You had a sense you were headed there, but what's a good, pragmatic way to adopt it? So, that's all it is. You're providing nonpartisan advice in this book. So, let's get into dollarization, and let's first talk about the arguments for dollarization, but then I want to respond to the concerns about dollarization. I know all of these very well, since you've been thinking about it for a long time.

Beckworth: Let's begin with what I think is the strongest argument for dollarization, and that is a pre-commitment device. It's a way to credibly tie the hands of the state. And John Cochrane, of all people, had a very interesting blog post recently, titled “Pro Dollarization.” And in it, he gets into the argument of why dollarization is better than an exchange rate peg, it's better than a currency board. It's much more credible. Now, he does go on to say, look, this is only one part of a bigger package. You have got to have fiscal reform. You have got to have structural reforms. You have to have them all together, so it's probably important to move fast. But, he makes the case that dollarization is a burn-the-ship strategy, where a currency board was not. He argues that even the currency board that ended in 2001 did not have the same pre-commitment, tie yourself to the mast, or tie your hands. Can you explain the differences? Why would dollarization be different than the currency board?

The Differences Between Dollarization and Currency Boards

Cachanosky: Yes, you touch on a number of important topics there. Something I want to clarify is that when we are arguing about dollarization in the book, when we talk about dollarization, we're thinking about a long-term solution to inflation. We're not thinking about some reform that will give you some control of the price level for a few years. We're trying to think of something that will survive the next government and the one that comes after and so on, and that goes to the commitment problem. Argentina doesn't have a commitment device. There's no credibility that the domestic policymakers will uphold anything they say, because they can turn against their own laws, their Argentine constitution, and nothing happens.

Cachanosky: You need something that builds credibility that does not depend so much on domestic policymakers. That's one of the things that dollarization gives you. Because it's not as impossible to de-dollarize, but it's way more costly and more difficult than any other monetary arrangement you can think of for Argentina, like an exchange peg, a currency board, a monetary rule, and so on. Argentina did have, sort of, if I can call it a currency board, in the 1990s. One of the big differences with the currency board is that you have the peso, which back then, the exchange rate was 1 peso equals 1 dollar, it was very easy. It's not just a fixed exchange rate, it's a convertibility law.

Cachanosky: It's like when you write a check and that check is redeemable in US dollars, or when you have the gold standard and your banknote is redeemable in gold. So the Argentine peso was redeemable in US dollars that were held at the central bank. The place where this was not truly a currency board is that the central bank did not have 100% dollar backing of those pesos. So if you go to the streets, what currency do you find in circulation in the hands of the public? The peso, not the US dollar. So, if you want to leave the currency board, technically speaking, it's not that hard. You take the law away, you let the exchange rate float, and boom, you're out. You have pesos? I'm sorry, those are not convertible to dollars anymore.

Cachanosky: Now, if you are dollarized, there are no pesos in circulation. All you have is a foreign currency, like the US dollar. Now, it's much harder for me, as a government, to de-dollarize. I need to go to your house, get into your house, force you to give me the dollars, and force you to get pesos that you don't want, or a new currency I'm issuing out from scratch because we don't have any currency anymore. So, the cost, the political cost to de-dollarize and the technicalities of how you de-dollarize, makes it more difficult than if you have a currency board arrangement.

Cachanosky: When Ecuador is talking about dollarization, they dollarized in January 2000, the reason they dollarized instead of applying a currency board, as we were told, is because they were already seeing how bad this could work by looking at Argentina. They say, I don't want to find myself, a few years down the road, where Argentina is now, since that was just before the 2001 crisis. The Argentine experience with the currency board was one of the information points of why Ecuador went to dollarization instead of another currency board.

Cachanosky: In Ecuador, years later, you have Rafael Correa, very powerful. He was able to reform the constitution, but he would never publicly, openly say that he wanted to de-dollarize, because that would have been too costly for him, politically speaking. He would have lost the elections. If you look at Zimbabwe, which is a weaker democracy, if you want, they de-dollarized, because if I'm the Zimbabwean head of state and I de-dollarize, well, I don't need to lose an election to stay in power, maybe. So, that's one of the main differences, is the institutional arrangement that you have when you dollarize.

Beckworth: Now, the pre-commitment advantage is one, as you just described, that it really ties the hands of the government, makes it very costly to go back to the original currency because it's no longer there, whereas the currency boards, as you noted, in 2001, it was still circulating, so it's easy to cheat, to break the rules and go back to doing that. That's the pre-commitment side of it. It really is a way to impose discipline when nothing else has been able to impose discipline. And as you said, maybe even if you got a good president and parliament who would impose discipline, there's no guarantee that subsequent ones would have that same discipline. You want something that can last beyond the current government.

Cachanosky: You cannot have… at least in my sense, in Argentina you cannot have, or you should not have maybe I should say, a monetary regime whose presence depends on me being in charge. The life expectancy of the Ministro de Economía, or the central bank president in Argentina, is very short. I think it's less than two years. So, you need a monetary arrangement that you believe is going to be in place regardless of who is in office. Because in Argentina, governments don't respect their own regulations, their own laws, and it's something whose-- any monetary arrangement whose presence does not depend on who is in office. It has to be independent of the government that is there at the time. That's what the dollarization brings you. And there's an interesting point, because there are two ways to think about the dollarization. One way is your end game, “I’m going to dollarization, and that's it, that's my end game.” Another way to think about dollarization is that, given the Argentine situation, dollarization is the middle step that then allows you to implement another monetary arrangement that you think will be better for the country.

Cachanosky: Let's say you want something like Peru or Uruguay, where you have a domestic currency running par to par with the US dollar. Well, it will be way easier to implement something like that if you dollarize, you put your house in order, and then you move to some other monetary arrangement, than if you try to go there right now. If you look years back, countries that de-dollarized when the dollarization was a much more common situation, it's easier to leave the dollarization if you are a credible government and you have credible institutions. It's harder to de-dollarize if you're like Rafael Correa in Ecuador or de Kirchner in Argentina. The interesting point is that once you dollarize, you make it harder to de-dollarize to bad governments and you make it easier to de-dollarize to good governments.

Beckworth: Now, part of the reason for going to dollarization is pre-commitment, but also, it cuts off the printing press, right? It completely severs it, the ability for the government to resort to that. If you look at a consolidated government budget equation, for example, the government can fund itself through taxes, through borrowing, or through printing money, the M-term in that equation. You're completely erasing that from that government budget equation. You're taking it completely away. So, what that means then, for anything it spends, it has to raise taxes or borrow, but if it's going to borrow, it's going to have to borrow in dollars, which could get very costly, and there'd be discipline imposed there as well.

Beckworth: So, you're taking away, I guess, what I would describe as the flow temptation, creating new money. Now, what you still have to deal with, though, is the stock issue, and we'll get to that in a bit. There's still the existing stock of peso debt or dollar-denominated foreign debt that the country owes, and we need to address that, and we'll come to that in a minute when we talk about your actual steps for getting there. But, the big thing is pre-commitment, you're tying the hands of the state in a manner that will last across many governments.

Beckworth: Let's look at some of the concerns that have been raised about dollarization. The first one that's been raised about dollarization is this: yes, I see the benefit of dollarization, yes, I would like to be there, and in fact, John Cochrane calls it, “take us to the promised land,” like invoking the children of Israel, wandering in the desert for 40 years, let's go to the promised land. Then, someone will say, “well, how do you actually get to the promised land? How do you get there? That's a nice story, but how do you get from here to there?”

Beckworth: I want to read John Cochrane's response, and I want to get your response to this concern as well. How do you actually get to dollarization? This is what John Cochrane says. He says, "And that leads to the primary argument against dollarization I hear these days. Yes, it might be the promised land, but it's too hard to get there. I don't hear loudly enough, though, what is the alternative? One more muddle of currency boards, central bank rules, promises to the IMF, and so forth? How do you suddenly create the kind of stable institutions that Argentina has lacked for a century to justify a respectable currency?" How do you respond to the critique that says, look, the reason we've had hyperinflation is because we lack state capacity. We lack the institutions. Why should we believe that we will have enough state capacity to get us over the hurdles to the end of the race to dollarization?

Responding to the State Capacity and Optimal Currency Area Critiques

Cachanosky: One issue with this line of criticism is, “Argentina shouldn't dollarize. Argentina should do Y, Z, and X,” where Y, Z, and X is your version of “do things right.” That, to me, is a nirvana fallacy in this case, because Argentina has a long history of showing that they cannot do things right. So, we need to be realistic about our options. Our options are, you have the Argentine central bank, or you dollarize. Having the central bank from Switzerland, having the central bank from Peru, that's not on the table, at least in the short run. That's one thing to keep in mind, and you run into this all the time.

Cachanosky: Then there is another issue. Okay, you don't want to dollarize. I want to do, I don't know, a currency union with Brazil, or have convertibility with the Brazilian real, or have the peso compete with the US dollar on equal footing, and so on. Any monetary design you think of that tries to keep the peso alive needs more dollars than you need to dollarize. In that sense, dollarization is cheaper than trying to keep the peso alive. Once again, years down the road, you can use your new dollarization in a macroeconomic environment to relax your own currency in a better situation than trying to keep the peso alive today.

Cachanosky: Now, there is a very large discussion of how many dollars you need to dollarize. My sense is that you don't need as many as the critics say, because what the critics are saying is, if you want to dollarize, there's no way that you can have the dollars you need to do this. This becomes more clear, why you don't need so many dollars, once you start to sit down and use Google to see how Ecuador and El Salvador dollarized, for instance. Once you see how it's done, you realize that you don't need as many dollars as your first impression. So it's not that out of reach. That doesn't mean it's easy, but it's not impossible. That's what I call an exaggeration of how many dollars you need to implement this.

Cachanosky: So, how do you go from here to there? Well, that's where how you dollarize is important. One way to approach dollarization, in very broad terms, is like a spot transaction. Give me all of your peso liabilities, here are the dollars. Another way is to approach this like a sinking fund bond. These are your personal liabilities, you change… and this is the key point, what dollarization is, is you change your legal tender currency. So now, that's the dollar, and then you progressively change your pesos to dollars. You don't need all of the dollars in cash, if I can put it in these words, on day one. Dollarization never happened that way.

Beckworth: So, like in Ecuador and El Salvador, they didn't completely wholesale dollarize. It was more of an incremental flow approach to dollarization.

Cachanosky: It has to be. Let's say you want to change the currency circulation, and we can talk about it in detail when we go into the step-by-step, but if I'm Argentina and I dollarize, I’m not going to have the 46 million Argentines making a line at the door of the central bank tomorrow waiting to change the peso for dollars. It's going to take time. You cannot do it on the spot.

Beckworth: Okay, well you touched on another criticism, and that is, is this going to be an optimal currency area? Is joining the dollar union going to put Argentina in an optimal currency area? The idea there is, if you're going to cede your monetary authority to some other place, some other institution, in this case, the Federal Reserve for Argentina, you either A, need to be on the same business cycle as them, or B, have shock absorbers in place like labor mobility, fiscal transfers. Of course, you don't. If you're Argentina, you're not going to get fiscal transfers from the US. 

Beckworth: Maybe labor mobility is decent, but probably not, but this critique also has its limits, because-- you've touched on this. The optimal currency area critique assumes you're going to have a nimble, technocratic central bank that eases when it needs to, tightens, and that the fiscal house is going to be in order. The people who invoke, I guess, the optimal currency area critique are implicitly invoking a central bank run by angels, right? A government run by angels, and that just, as you said, hasn't happened in Argentina.

Cachanosky: Well, as I said before, you're going to run in the topic of dollarization with the nirvana fallacy all over the place, explicitly or implicitly. There's another topic, and it's that we're not talking here about, let's remove the peso from currency area A and replace that with money from currency area B. The situation is that in currency area A, you already have currency area B in place, which happens also to be the world reserve currency. So, currency area B is in areas A, B, C, D, E, F, G and all of the alphabet. So, you are adopting the world reserve currency, not just some other country’s currency, and that's something that, sometimes, is missed.

Cachanosky: When I hear the optimal currency area critique, I think it's a misapplication of the model. This model is well thought, if you want, for a developed country that uses its own currency, and also, it issues debt on its own currency, which is not the case for Argentina, Argentina has and additional thing. They have to issue sovereign debt in dollars, and that's another reason to dollarize, to eliminate the currency mismatch between the tax revenue currency and what they have to pay for debt. Also, keep in mind, once we're in the real world, we're not going to have the ideal situation. We're always picking between second best.

Beckworth: Always second best, yes, and another great reminder that Argentina has largely dollarized already, so we're not starting from scratch. We're not starting from, as you said, a complete zero dollars and then having to go full dollarization. John Cochrane, one more quote from him on this point, though, on why the optimal currency area idea does not really apply here. Again, he's alluding to this fact that some people want to invoke that, “well, what can you do if you don't have central banks finely tuning the economy?” And so, he says this, "The lure of technocratic stabilization policy in the face of Argentina's fiscal and monetary chaos is like fantasizing whether you want the tan or black leather on your new Porsche, while you're on the bus to CarMax to see if you can afford a 10-year-old Toyota." 

Cachanosky: I like that passage. It's very clear.

Beckworth: Very good analogy.

Cachanosky: Yes. Let me say something about the shock absorber issue, which is an implicit call for a well-behaved central bank. Here again, what you have on the table is, Argentina has a central bank that we already know it can have, the Argentine Central Bank, or dollarization. If you look at big crises, big shocks, like the 2008 crisis, or COVID-19, with the shutdowns and all these issues, if you compare Argentina against the dollarized countries in the region, Ecuador, El Salvador, and Panama, the dollarized countries manage foreign shocks better than Argentina.

Cachanosky: So if Argentina, the reaction to a big shock, historical proportion like 2008, were similar to the dollarized countries in the region, Argentina would have done better. Real GDP in Argentina in 2008 fell almost 6%. In Ecuador, it remained positive. In El Salvador, it fell, I think, like 1.2% or something like that, and Panama, somewhere around zero. If you cannot reach that well-behaved central bank, dollarization may be a step up for you, because your central bank is so bad, that you might be better off without one. If you look at the reaction against COVID-19, you have a similar story. Dollarized countries were not affected more than Argentina because it's not dollarized. So, the foreign shock concern, it doesn't show up clearly in the data.

Beckworth: Alright, and again, Argentina is starting from a place where, at least, the private sector has lots of dollars. People use it. It's not something completely foreign. And again, the motivation for your book was pragmatic. It was like, "Look, we're headed in this direction. How can we do it in the least distortionary, least costly way, making that transition to dollars?" Alright, let's move on to your steps for dollarization. In your Substack, it's called Economic Order. You had an article in October, titled, *How to dollarize Argentina.*

Beckworth: You put it into three different steps, so there's three buckets. There's three types of liabilities that need to be dollarized: bank deposits, currency in circulation, and then central bank liabilities. And you say, with bank deposits, you have got to dollarize them pretty fast, currency circulation, kind of slowly. You've already touched on the currency point, I think. And then, central bank liability is really slow. That's the slowest. I think that's also the biggest challenge there. Walk us through those three steps and how you propose that Argentina should dollarize those three different groups of liabilities.

The Three Steps of Dollarization

Cachanosky: Yes, the preceding issue to that is at which rate you dollarize. Conceptually speaking, you dollarize at the exchange rate of equilibrium in the market of whenever you are dollarizing. The concept is, if I have-- my wage is paid in pesos, and I convert that into dollars, I get to a dollar number. When you dollarize, you should get the same dollar number. Now, the exact exchange rate depends on when you dollarize. It's not the same if Argentina wants to dollarize in December, January, February, March and so on, because that rate will change. But conceptually speaking, you want to swap your currency at your equilibrium price or around your equilibrium price.

Cachanosky: I find that it's useful to separate what you need to dollarize into these three buckets. The first one I mentioned is the bank deposits. This is the fastest to dollarize because it's basically a change in the unit of account into your bank account. You log in into your bank tomorrow, and your bank deposit went from so many pesos to so many dollars. That's it. You're transferring to your bank account and you're transferring out from your bank account, that becomes dollarized. The whole banking system is now dollarized.

Cachanosky: This is the easiest part, and we can talk about this later, if you're not facing a bank run, because now you need to have that cash to make the withdrawal, so as long as you don't have that situation, dollarizing the bank deposits is not a complicated part. And now, you don't need dollar cash, but you don't need a lot of dollar cash if you want to dollarize the bank deposits, maybe the reserves, but not the whole deposit. It's not that you need that big amount of dollars to make it whole.

Beckworth: Let me ask you a question about that first bucket in making that transition. What is it actually like in Argentina? Does the public use peso denominated checking accounts? You've touched on already, there's a lot of dollars being held. Are they physical dollars? Are they dollars in bank accounts? What, actually, does a typical Argentine bank do in terms of currency denomination?

Cachanosky: Well, most of the deposits are in pesos and there are very strict capital controls, so it's very difficult to be able to have access to buy dollars at the official rate. That's why you have the underground dollar market and so many different exchange rates across the economy. You have some dollar deposits, but I don't think those are the largest ones. Now, the second bucket that you have to dollarize, which is currency in the hands of the public, you can approach that in different ways. Now, one way is what Ecuador did. They imposed a compulsory dollarization of the sucre. I think they gave a time frame of something like nine months for you to change the sucre for dollars cash. After that, the sucre loses validity.

Cachanosky: Now, the central bank needs to have the dollars to swap all of the sucres in nine months and you need to go all around the country, you need to go to the people and change those bills. El Salvador did something different. El Salvador, when they dollarized, they said, "Well, the colones, our domestic currency, never loses validity. You can use colones as long as you want. They're valid forever, like the balboa in Panama." In that situation, you can imagine a central bank saying, "Well, my issuance, my money, never loses validity, so I don't have to go and buy it for dollars. So now, I don't need the dollars to change the currency circulation.” If you want to dollarize, you can do that in two ways. 

Cachanosky: One is, you make a bank deposit because banks are dollarized. So, if I go with my pesos to the bank and I make a bank deposit, now those are dollars in my bank account, so I dollarize myself. Another way to dollarize my pesos is to pay taxes. I go to the government and I pay taxes in pesos and those become dollars once they get into the government's bank accounts. In El Salvador, to change all of the currency in circulation from the colones to the dollars, that took around two years because it was voluntary, it wasn't compulsory. Now, an interesting point, if you look at the dollar reserves at the Central Bank of Ecuador when they dollarized, and you look at their balance sheet, you see that the currency in circulation, the sucres, they are going down as they are dollarized.

Cachanosky: If you look at the central bank reserves, they are not going down. They remain stable. It's not that the sucres were going out of circulation at the expense of the central bank reserves. What was happening is that bank deposits were going up, and there was a large amount of the public that they dollarized through the private sector, through bank accounts, instead of through the central bank. So, if you do something like El Salvador, it's going to take you a number of months to dollarize, and it doesn't require a large amount of dollars. For Argentina, where institutions are so weak, and the proposal is trying to make this as strong as possible, you can make a combination of both.

Cachanosky: And you can say, okay, we're going to sound like El Salvador with voluntary dollarization. One year from now, if the currency of pesos falls below a certain threshold, one-third, 25%, whatever value you say, you automatically switch to an Ecuador case. Now the central bank has the mandate to withdraw the remaining pesos in circulation. That gives the central bank two advantages. One, it gives the central bank time to start to collect dollars to change the pesos one year from now, whatever time frame you pick for this automatic referendum, if you want. And two, it decreases the amount of pesos that you have to dollarize because a big portion of that happens voluntarily through the banking sector. So, that would be a way where you can combine what Ecuador did and what El Salvador did. So, for this bucket, again, you can do it without a large need of dollars, and you take your time for it.

Beckworth: Alright, that's the first two buckets, bank deposits, and currency in circulation. Let's now go to the one that's the most challenging, and that is central bank liabilities.

Cachanosky: So, how do you dollarize that part? That's the most complicated part. The situation is that the Argentine Central Bank is, technically speaking, broke. That's something, and this is something to keep in mind, that you have to fix whether or not you dollarize. There are a lot of things that Argentina has to do whether Argentina dollarizes or it doesn't dollarize, like depreciating the peso, revising some subsidies, and so on. There are other things that Argentina has to do regardless of dollarization, sometimes people are saying that you have to do it because you are going to dollarize, and no that's not the cost of dollarization, it's the environment within you are to dollarize.

Cachanosky: So, how do you go about that? I'm going to divide it in a few steps, the way we thought about this proposal, and the step division is again to make it pedagogical. So, if you look at the Argentine Central Bank on the asset side, they have a bond portfolio of Argentine Treasury bonds. Those Treasury bonds are non-tradeable. The central bank cannot sell them to perform open market operations. That's the main reason why the central bank has been issuing their own central bank bills or liquidity bills, the [Letters of Liquidity] or LELIQs.

Cachanosky: Step one is, the Treasury will take that portfolio of Treasury bonds that the central bank has, and it's going to swap them for new Treasury bonds issued under international law. The amount of debt in these bonds is the same. We're not talking about an issue of new debt, we're talking about changing non-transferable debt to bonds that you can actually trade in the market so that they can be valued and they have a better standing and so on. So, that's step one.

Cachanosky: Step two, the Treasury will take those new bonds, and this is important, we are not saying that the Treasury has to sell the bonds to the market to collect dollars because no one in the market wants to lend to Argentina anymore. We're not talking about, here, dumping bonds into the market. What the Treasury will do is take these bonds and relocate them into an international trust outside of Argentine jurisdiction, a special purpose vehicle outside of Argentina. In this trust, on the assets, you will have the new bonds coming that were originally at the central bank. As these bonds pay coupons, principals, this trust starts to collect the cash flow. Now, what is on the liabilities of this trust?

Cachanosky: These central bank liabilities are denominated in pesos, they get dollarized and they become, if you want, dollarized LELIQs, like a short commercial paper, that is issued, and this is important, not by the Argentine government, is issued by the trust. So, if I'm the trust, now I have these dollarized liabilities that used to be the central bank liquidity bills, and I have an inflow from my assets of, I don't know, $20. I'm going to pay off $20, all over the remaining. Next year, I get the new cash flow, and I pay off, with that cash, for some of these bills, and I roll over the remaining.

Cachanosky: That's the basic functioning of this situation. Now, this trust, the way I described it so far, is very highly exposed to Argentine risk, because it basically has Argentine bonds on its assets. So, what we propose is that, if this is implemented, the trust, you should diversify the source of its cash flow as much as you can. I'm going to give you a couple of examples, maybe others or whatever, but the point is that this is an example. So, what other source of money can this trust have that will not be the Argentine government?

Cachanosky: One option is to say, well, you are a new government. You have, in Argentina, taxes through exports. You cannot remove that on day one. So, if you are an exporter, and you have to pay $100 in taxes, you can send, I don't know, $20 to the trust, $80 remaining dollars, you send that to the government. Now you can have an inflow of fresh dollars coming from exporters, not from the government. Another option is, if Argentina starts its 5G network, the proceeds of that transaction, that can go to the trust as well. The point is that, diversify as much as you can, the source of that info to the trust.

Cachanosky: Now, once the trust is done paying off all of these dollarized liquidity bills that the central bank originally had issued, it automatically self-liquidates, and all of the remaining assets go back to the Argentine government. So, all of those bonds that you issued that never hit the market, now they get canceled. So, what you see when you look at the total debt of the government is a reduction by that amount. You can have other additional financial instruments and arrangements to this trust to make it stronger, but that's the basic functioning of this proposal. The key point is that you have this large amount of central bank bonds that you have to do something with, and because you cannot buy them outright, we are going to dollarize them and treat them like a bond and pay them off as a sinking fund.

Cachanosky: This gives you an important advantage because you're making these bonds swap, that [when] you take the Treasury bonds at the central bank and reissue them in a new format, you can play with two variables. One is, let's say Argentina dollarized in 2024. As you mentioned at the beginning, Argentina is running a large deficit. And now these are bonds that the Treasury cannot roll over anymore, they have to start paying. So, you can say, these bonds are going to start paying in 2025 or 2026, so you can start with a grace period to start paying off these bonds, instead of having the Treasury having to pay a new bill from the beginning. The other thing you can do is, you can manage the timeframe of this.

Cachanosky: Maybe I want to pay off all the LELIQs in four years. Well, maybe I can't, that's too much. Well, I made this bond pay off the LELIQs in five years, six years, seven years, eight years, whatever I need. So, you have this freedom to coordinate with the Treasury, so that you can make sure that these bonds are going to be paid. The idea is that this trust will work like a computer. Every dollar goes in, it's like a rule, automatically it’s used to pay off LELIQs. There is no discretion or any involvement by the Argentine government here.

Beckworth: And you call this trust the Monetary Stabilization Fund, is that correct?

The Monetary Stabilization Fund

Cachanosky: That’s correct. I think the reasoning behind this name is that the problem in Argentina is that the central bank is bankrupt. Again, if you don't dollarize, you still have to deal with this. The whole idea of this fund is to recapitalize the Argentine Central Bank in a credible way. The best way this would work is if you do something serious, like dollarization. The best way many reforms will work in Argentina for the new government is if you do something credible, non-reversible, or hard to reverse, like dollarization. If Milei wants to ask for a loan from the IMF, or a financial bank, or whoever, I need to convince you that, even if I'm not in office, this arrangement will still be in place and the organization delivers that. But, if my promise is, “as long as my central bank president is in office, this is going to work,” that's not going to fly, because that has a very short time period.

Beckworth: Okay, so, just to be clear that the Monetary Stabilization Fund, this trust, they would issue short-term commercial paper or their own bills? Would they be denominated in dollars?

Cachanosky: This is not a financial instrument that has never been used before. It's very common in the financial markets. So, what this trust is, is it’s a special-purpose vehicle, and what it issues is asset backed commercial paper, that is short-term denominated in dollars, that is replacing the LELIQs. We are not telling the banks, "You have to give me that one in pesos and I give you this long term in dollars because I can get in the way of your maturity mismatching." It's, no, you can have this short, asset backed commercial paper, the trust is going to have an excess of collateral to make sure that if your priced bonds are changing, you're not running into problems.

Cachanosky: This commercial paper can be traded in the secondary market. Ideally, you can find an investor that is willing to buy, at a high discount, these dollarized LELIQs or this commercial paper, so you take it outside of the Argentine commercial bank's balance sheet, and they can hold it until maturity and make a profit from that high discount at the beginning. So, there are a lot of things that you can play around with that are very common in developed financial markets, that are not very common in Argentina or not present in Argentina because the Argentine financial market is small and not very dense.

Beckworth: So, this deal is just with the government bonds that were on the central bank’s balance sheet, the ones that they could not trade, they weren't marketable, but there is this other area of the balance sheet that's also problematic, these liquidity securities. What's your solution there?

Cachanosky: No, this is dealing with both of them. So, in very simple terms, what's happening here is that the Treasury is going to pay the debt issued by the central bank. But I do that through the--

Beckworth: --Special purpose vehicle. So, you're effectively transferring all the liabilities… well, not all, but most of these liabilities, from the central bank’s balance sheet onto the balance sheet of the Treasury.

Cachanosky: The financial assets and the financial liabilities of the central bank, they get transferred to this trust, to the SPV. So, the financial assets, the Treasury pays that, who is the one holder of the trust? The trust collects the cash flow. What happened to the central bank’s financial liability, because in our proposal, the central bank is closed down, shut down. So, the central bank liabilities, when they are dollarized, they became replaced by a commercial paper issued by the trust. How does the trust pay those liabilities? By the cash flow it collects from the Treasury bonds, plus the contribution from exporters in Argentina, and anything else that you would want to put into that trust.

Beckworth: Okay, so we have our three buckets of liabilities that need to be dollarized. We talked about bank deposits, currency in circulation, and then central bank liabilities. Again, that last one is the thorniest, toughest one to deal with. Let's go back to the first one, bank deposits. You had another article out on bank deposits and dollarizing them because some people are fearful that there could be a bank run if you did this. I'm not so sure because, "Hey, man, my pesos are going to be turned into dollars. Maybe I want more deposits." Walk us through the concern there and how you address it.

Addressing Bank Deposit Dollarization Concerns

Cachanosky: Yes, let me just make a final comment about the central bank liabilities. In that way that you do it, again, you don't need all the dollars to buy, outright, the central bank liabilities on day one. You spread this out [over] a number of years. Okay, so, this is a concern, right? Argentina is probably the country with the highest amount of dollar bills per capita because Argentina has a very long history of very bad money, bad currency. They don't want to save in pesos, it doesn't make sense to save in pesos. Everyone wants to save in dollars, even if it's under the max. The concern is, “wait, you're telling me that my bank deposits, in pesos, now they are dollars? I'm taking those dollars out of my bank account right now because I want to have the cash in my hands to make sure that no one will mess up with my bank deposits again.”

Beckworth: Okay, so that's the argument.

Cachanosky: That's where the concern is coming from. It's more like an Argentine psychological situation with the pesos and the dollar relationship. So, this point that you mentioned is… I lay out a few points, if you want, of why I think that's not a very likely scenario. By this, I don't mean to say that we shouldn't worry about the bank run problem. What I'm saying is, I'm not so sure this has to happen. One reason is, let's go back and see what happened [with] countries that dollarized in a very complicated situation like Argentina. We have Ecuador, which is an important case for Argentina.

Cachanosky: They dollarized with the political crisis, stepping out of a banking crisis, with all of the problems. If there's one thing that Ecuador shows, it’s that you don't need ideal conditions to dollarize because they dollarized in the worst situation possible. So, what you observe is the money going back to the bank accounts, even if, in real terms, banks were offering a negative rate. You will be losing money by going into the banking system and people were still putting the money back into the banks. A reason for that, or two reasons, is that, well, what are your expectations going forward that will happen with this economy now that you dollarize?

Cachanosky: But, two, and this is to a second item of why it's hard to think of a bank run in Argentina, is that you are going to the bank, not only for the banking services, but also to make use of the payment technology and payment network. I need to pay my bills, I need to pay taxes, I need to pay wages, I need to pay the grocery store, I need to be paid, and so I need to be connected to the banking system. And if you look at the banking system in Argentina, a very large proportion of the deposits are for transactional reasons. It's money that, even if I take it out today, I need to put it back in the bank tomorrow.

Cachanosky: The money that we didn't want to have at the banks is out already. Another reason is that, as I mentioned before, if you're dollarized, you are dollarizing at the equilibrium rate of the market. That's a very different situation that you have with the official exchange rate today in Argentina, where the dollar is cheap. That'll give you a shortage. So, this is not a situation where I have pesos in my hands, and I go to the bank, make a deposit, and withdraw the dollars, and I'm going to use the banks to buy dollars cheap. Now, the exchange rate is going to be high. It would be at the equilibrium point.

Cachanosky: It wouldn't be cheap for me to sell you the pesos, give me the dollars. I should be indifferent at the margin between holding pesos and dollars. This leads to the next item. Especially at the beginning, you're going to have a small change problem. I want to pay in cash at my grocery store or something like that. I need more change. In Argentina, the dollar bill is a $100 bill. You don't have $5, $10, $20. So, I will need, and I will want to have pesos. Now I feel safe because our dollar is at a fixed rate to make my cash purchases, and I’m not afraid that the value against the dollar will depreciate when the dollarization process is a fixed rate.

Cachanosky: And two, I know I can get the pesos away from me very easily. I mentioned, you can pay taxes, so you give the pesos to the government. If I'm buying something from the store, the store manager is happy to get the pesos because he knows he can put it in the bank and they will become dollars, and he can pay taxes and they will become dollars. So, the store manager can also get rid of pesos very easily, so it wouldn't be a problem to have pesos in this transition period. Then you have other things you can do. One is the bank… if you want to withdraw dollars in cash, instead of giving you the dollar bill, it can give you a Visa card with the amount of dollars you want [on] the card.

Cachanosky: This is pragmatic. I don't have to be walking around with a big pile of dollars, because it's just the card, but it's also safer. You're not going to run into the problem that, something's happening in Argentina where you can get someone mad at you when you step off the bank for trying to steal your money, because now I have a card which is safer. If you don't have the pin code or some security, you cannot use it, so it's also safer. And there's another component. If you dollarize the central bank liability with the trust I was mentioning, and this works out well, this trust, because you will have, ideally, a nexus of collateral that can be used to acquire dollars to send to Argentina to deal with bank withdrawals or anything they need, if needed. So, if I put all of these items under the table… and again, I don't want to say that no one should worry about bank runs, but I don't see it as very likely and there are ways to deal with this. So, the concern of a bank run is not the reason to not dollarize. It's a reason to just look at it and deal with it.

Beckworth: Okay, we'll provide links to that article and the other one we were talking about on the steps to dollarization. Now, Nicolas, in the time we have left, and we're nearing the end of the program here, I want to touch on some recent developments in Argentina. So, president-elect Milei, he was very pro-dollarization. That's the reason we're talking about this. That's the reason that people have been commenting on it extensively. But now, there seems to be some dialing back of the urgency for dollarization. In fact, I'm looking at a Bloomberg article, and the title is, *Argentina Dollarization Is Medium-Term Goal, Caputo Tells Bankers.* This is some official in the Milei administration. But, what is your outlook or your expectation for the path forward for dollarization in Argentina?

The Current Outlook for Dollarization in Argentina

Cachanosky: My expectation is the same as what I had when we started working on this book, that if Argentina is going to dollarize, it's going to be by the economic conditions getting worse and worse, and the economy just forces you to dollarize. There are two ways you can act with dollarization. One is like insertion, and you do a very precise dollarization process. The other way is to become a voucher, and so you have a scalpel, you have an axe and you start throwing the axe until you dollarize. Argentina is closer to the voucher side, regrettably. We would prefer, if it's going to happen, use a scalpel.

Cachanosky: Basically, what happened is that my co-author was publicly announced to become the next, and last, central bank president with a mission to dollarize. After Milei was elected president, we’re seeing a change, and now we have this new person, Caputo. For what we know, looking at the media, what Caputo wants to do is not compatible with Emilio's implementation plan. It seems that Caputo is having the upper hand and he may be… it's not confirmed yet, but he may be the next, either central bank president, or Minister of Economics.

Cachanosky: So, from what we can tell, what it seems that Caputo wants to do is to delay. If he wants to dollarize, he wants to delay things. He wants to, first, heal the central bank balance sheet, deal with the LELIQs, then dollarize. In our approach, we want to deal with the LELIQs within dollarization. We think that doing that is safer and less dangerous than trying to deal with these different problems, isolated. So, two things can happen. One is, Caputo is successful in this plan and nothing bad happens, and the urge to dollarize goes away, Milei doesn't have enough political power to push the topic, and Argentina doesn't talk about dollarization until the next crisis five years down the road. I don't know, one option.

Cachanosky: Second option, Caputo’s plan doesn't work, or he also says, like many people are saying about Milei, “I step down,” and the economic situation gets totally out of control. We are talking about a very serious hyperinflation scenario, and then you dollarize by force. You don't have a choice, which is a scenario that, when we're starting to talk about the book, for us, what's the most [likely]? If you look at Argentine policymakers and the Argentine economy, it's like there is a collision path.

Cachanosky: Policymakers are not going to talk about dollarization until they don't have any other choice, until it's too late, basically. So, I wouldn't say that dollarization is off the table for Argentina. This is not an unlikely scenario, what we are seeing today. For those who follow Argentina, this wouldn't be a surprise. Now, we have a few days until Milei takes office. We know for sure what the economic plan will be, and that will give us a more clear scenario moving forward.

Beckworth: Yes, I should tell the listeners that we are recording this on November 27th, so a lot could change between when this show is recorded and when it comes out, but we'll be following up and paying close attention. Well, with that, our time is up. Our guest today has been Nicolas Cachanosky. Nicolas, thank you so much for coming on the show and discussing dollarization in Argentina.

Cachanosky: Thank you, David, and thank you to the audience.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.