 It's my great pleasure to announce the Friedrich A. Hayek Memorial Lecture sponsored by Donald and Judy Rembert. Nicholas Kachanowski is an associate professor of economics and director of the Center for Free Enterprise at the University of Texas at El Paso. Senior fellow at the American Institute of Economic Research and fellow of the Yusema Friedman Hayek Center for the Study of a Free Society. He also serves as associate editor of the Southern Economic Journal. Kachanowski is past president of the Association of Private Enterprise Education and a former director of the Mont Pelerin Society. His work has been published in outlets such as the Cordley Journal of Austrian Economics, the Review of Austrian Economics, Review of Financial Economics, Journal of Institutional Economics, Public Choice, and the Journal of Economics, Behavior, and Organization, among others. He is co-author with Emilio Acampo of Dollarization, a solution for Argentina. He will address us today on the topic of a case for Argentina's dollarization, why and how to implement it. Please welcome Dr. Kachanowski. Thank you all, thank you the institute, thank you the donors, thank you everyone for inviting me to be here as I was talking with you. I think my last time here was something like 10 years ago, so I'm very happy to finally make it back. Okay, I want to split my talking three parts. The first one is why there are talks about dollarization in Argentina, the dollarization case if you want. This topic by itself can take us hours. I want to focus mostly on Argentine-specific issues or arguments. The second part is, well, how you do it? And I get that the question a lot. Okay, Nicolás, you talked me into dollarization, but how this happens? So that will be the second part of the talk. And the third part is what's going on today? Is there any chance Argentina will dollarize? What's going on now that Millay, who advocated for dollarization, is president? Okay, why dollarize Argentina? What's going on? If you look at this country, you have decades, a large number of years of monetary mismanagement. We're not talking about just the last 10 or 5 years of high inflation. Since 1945, at least Argentina has high inflation. You have high inflation, volatile inflation with all political parties, with any type of government, with signals to you this is an institutional problem. It's not a matter of choosing the right central bank president or choosing the right government. We always have high inflation. An institutional problem requires an institutional solution. If you look at Argentine history, when you have currency boards, types of monetary policies back in the late 19th century and the 20th century, those are the times where you see the macro of Argentina in better shape or not so bad as its standard. So when you have strong monetary regimes, this is when things seem to be working a little better. So you have long-range economic underperformance. You want to produce an institutional shock if you want to change that overall trend and performance. So let me show you some numbers. This is the yearly inflation rate in Argentina since mid-1940s until, I think, a couple of months ago. It's very volatile. It's very high. Pay attention to the vertical axis and you will see how high those numbers are. If you take that time frame, the average inflation rate is 60% per year. We have, in average, 60% inflation per year for 80 years. The only time where you have inflation more or less under control is the 1990s, which is when we had this sort of currency board, the closest you can sink in Argentine history of being dollarized. Other than that, nothing works. Argentina is, I think, the only country you can find that implements the famous and fashionable inflation targeting regimes and fails. Any other country they do that, it works. In Argentina, it doesn't. So you have a very deep institutional design problem here. This has consequences. So here we have, in 1880 until 2016, the ranking worldwide of income per capita in real terms. For a number of reasons, Argentina likes to compare itself with Australia. Similar weather, similar agricultural production and so on. And Australia is a country that Argentina likes to compare to. We want to be like Australia. That shady area, if you are in there, you're in the top 20% income per capita worldwide. That's Australia, right? Flatline, always doing pretty well. I'm going to applaud Argentina. It did pretty well once the country becomes geographically solidified in 1880s. And at some point in 1945, if I remember the year correctly, Perón decides to change the constitution, and that becomes an important institutional shock, and you start to see Argentina falling in the ranking. You have a downward trend. It doesn't matter what you do, you have a downward trend. Some years you do a little better, like in the 90s, other years you do worse. The last few years is really bad with taxation. The idea behind a strong monetary reform like dollarization is to change the trend, not just to change how you are doing in a few years. And changing a trend requires a big institutional shock. Dollarization is part of that menu. This is more recent. So now we have what's happening in the last 20 years. In the recent taxes, you have how many of the last 20 years your GDP had a negative growth rate? You are producing less than before. In the vertical axis, you have how many of those years your inflation rate is more than 10? The farther you away from the origin, the worse, right? You want to be very close to the beginning of the graph. These are all the countries I found information for. One of those is Argentina. Which one do you think is that? But hey, we're talking about Argentina. This is not Iran, Sudan, Yemen, Zimbabwe, Libya. Don't go crazy. That's Argentina. Pretty bad. Who is Argentina surrounded? Who is close to Argentina? Iran, Sudan, Yemen, Zimbabwe, and Libya. We are not as bad as Venezuela, but we might be getting there if you don't change course. So if you look at the last 20 years, you have a large number of years worldwide where you have very bad macro performance. High inflation, more than 10% your GDP is falling. The point of showing this graph, and this is only for my Argentine audience, to realize that you are doing really bad. You don't fix this with an aspirin. You need something stronger. Those three, El Salvador, Panama, and Ecuador, those are the three dollar ice countries in Latin America. They are doing pretty well. So how do you go from there to here? Can you do that without dollarization? That's the underlying debate, no contention in this debate. What people that advocate for dollarization say is you need to have a strong, credible institutional reform. Dollarization gives you that. If you cannot do that, if you start at road, it's going to stop like we did so many times before. This is the inflation rate in Ecuador. They dollarized in January 2000. That year, the inflation was 96%. The next year, it falls more than half to 37%. The year after, it falls again more than half to 12%. And then it remains flat, around more or less US levels of inflation. Even if you have Korea's president, even if you default, even if you are hit by the 2008 crisis, it doesn't matter what happens, your inflation gets anchored more or less around US levels. We're not talking about a super free economy here. When we think about dollarization in Argentina, and I want to clarify, dollarization basically means you remove your domestic currency and you adopt a foreign currency as your currency. In the case of Argentina, that would be the US dollar. When we're working on this reform, we try to optimize something with some constraints. We are economists, that's what we do. We optimize with constraints, I guess. One of the things that this reform is trying to do and other reforms discussed in Argentina may be trying to maximize something else, like how much the central bank can do. But that's not what we're objective. What we are trying to do is minimize the likelihood that the reform will fail. We are working under the assumption that Argentina has no margin of error. The value at risk, if you put the reform and face again and you walk into another crisis, can be really, really bad. So our objective is you cannot miss. You have one bullet left in the gun. The hungry lion is running to you. You cannot miss a shot. So we're not trying to optimize what the central bank will do in New Argentina. We want to minimize the likelihood of mistakes. And that's something to keep in mind when you look at any monetary reform, what is that this reform is trying to optimize? Some constraints for any reform, dollarization or not, the central bank in Argentina is bankrupt. Oops. You have a lot of central bank liabilities like in deposits in the commercial bank. So you need to be very careful how you deal with those. Domestic politics is not only non-credible, they cannot create credibility. Nothing they say will be believable. So how you create a credible reform if you're not credible. Institutional anatomy, this basically means you pass a law and it's worthless. Argentina goes back over their laws and nothing happens like that overnight. So you can declare that the central bank is independent by law and that's meaningless. And we prove that repeatedly. Then there are some political reasons why you may think about the realization. Whoever was going to be the new government they were going to take office in a very difficult, put it in a nice way, scenario. Argentina needs to do a lot of things. Balance the budget. The labor reform, open to trade and you can make a very long list. Those reforms take time to implement and takes time to see the effects. The new government balance the budget in January and February and we don't know if that's going to stick until the end of the year. We have to wait and see to be sure. You don't have that time. Before you know it you are in midterm elections and now your whole incentive change. You don't have to wait until the elections in Congress. Dollarization is fast to implement and has a faster impact on the price level. Now you have the political space, the political bandwidth, the political capital and incentive to move forward with the other reforms. And this is one of the main reasons why we were advocating at least I was advocating that if you want to dollarize you should do it sooner than later because if you change this and try to dollarize later the time may play in the future. So if I put the summarized section the different monetary reform discussed in Argentina have a central bank independence by law have by monetarism which basically means have the Argentine peso and the dollar compete with each other and the equal conditions in the market. This is the most popular right now have the peso convertible with the Brazilian real that was a real proposal technically consistent. Meaning if you start them they can work in theory. They won't break down by themselves. But those three are not credible because they depend on domestic politics. Dollarization doesn't depend on domestic policies and it's credible. It's very difficult to undo and that comes with the credibility component that you need for this to work. So where do economists disagree on the dollarization topics? I think there are two main issues. That's Argentina have enough dollars to dollarize. I hope I will show you in the next slide that you don't need as many dollars as most critics think. The other one is the credibility assumption. Whether you think that you can create the needed credibility for other reforms to work. If I look at Argentine history my reading of Argentine history is that that empirical evidence says you don't have the credibility. It's very unlikely that you're going to be able to sustain this in the long period of time. Other than your intuition and what you can think in the white world was your evidence that Argentina can create that high level of credibility. And that's where most, in these two points, where most of the debate takes place. Okay. Maybe I open your mind to think that dollarization might be a good idea for Argentina. So how do you do it? Every country dollarizes in different ways. This is not like one menu that fits everyone. I like pizza with pepperoni. You may like pizza with, I don't know, something else. Nothing wrong. But both of them are pizzas. So there are different ways that you cook dollarization. The first thing to keep in mind is that you need a dollarization rate. At which rate you change the pesos to dollars. Conceptually speaking, this is your equilibrium exchange rate. If you're in Argentina and you pay your money to whatever you can, your legal market or the black market to buy dollars, this is how many dollars you get once you transform your pesos to dollars. Once you dollarize, you should get your same dollars. Now, what the number is depends when you dollarize. It's not the same if you dollarize this month, next month, one year from now. So no one can give you a specific number because it depends on when you want to do this. But conceptually speaking, you want to dollarize around your money. Now, I find it easy to separate what needs to be dollarized in three groups. The first one is bank deposits. This is the one that you can dollarize the fastest. Then you have the currency circulation, the pesos that people have in their wallets, that store managers have in their stores and so on. And then you have a very specific Argentine problem which is the central bank liability. The Argentine central bank has reached a large number of short-term liquidity bills. They are in pesos and they are in dollars. So I'm going to go through all those three from the fastest to the slowest which is also the easiest and the most difficult. Okay. So bank deposits easy. You set your dollarization rate. Basically what happens with bank deposits you swap those unit of account from pesos to dollars. So I log in into my online bank tomorrow and my pesos were converted to dollars at the dollarization rate. So you have a lot of physical dollars to do this. It's as if it were digital money. In the bank account, it changed the unit of account. When you need dollars is in the case that you're going to face a bank run. Which in Argentina is a very big concern. I'm Argentine. I'm in Argentina and you tell me my pesos are now dollars. I'm thinking that of the bank right now. That's a concern. So I think this is unlikely that you're going to see a massive problem. So I'm going to talk about the reasons. One is, okay, let's look at international experience. When Ecuador dollarizes in 2000, they see an inflow of money going to the banks. They had a banking crisis last year, not 20 years ago like the case of Argentina and the real interest rate was negative. And money was flowing to the banks. A reason is that the realisation shifts your expectations but also you go to the bank because you want to invest. We should let's do the next point. Bank money in Argentina today is transactional. The money in the banks is the money because I need to use to make payments. So even if I take the money away today, I need to put it back in the bank because I need to use the transfers and all that. In the short run, you're going to need small change. If the assumption is you want to take your money away and I want my cash. When I go to the grocery store, I need small change. Which in Argentina you don't have in dollars. The lowest nominated dollar bill is 100. Okay. So I need change. I will want to have pesos because in pesos I can have small change. And I don't mind their pesos because I know I can get rid of the pesos very easily. I make a bank deposit, they become dollars. I pay taxes. I give the pesos to the government. And when that goes to the bank account, they become dollars. Or I used to buy at the store and the store manager says do you give me pesos? No problem. I can make a bank deposit or pay taxes. So once you dollarize having small change in pesos is not much of a concern. It's not a problem. This reform includes a banking reform. Part of this reform is establishing what we call the Argentine Bank of Reserves or Banco Argentino de Reservas. This will be in an international safety jurisdiction outside of the government, Argentine government reach. This will be an extra component of safety to your deposits. And the idea is if you are the public and I'm the government, it's easier and faster for you to move the money around than for me to grab it if it's outside Argentina. And the fact that you can move faster than me is in itself a defense mechanism. And then banks, if you want to withdraw dollars instead of giving you this back of dollar because you don't trust the government. It's more pragmatic for you to be with a car than a stack of paper bills and it's also safer for you. Because if I steal your dollars, I can use them. But if I steal your car, I cannot use that. And that's a concern actually in Argentina. So it's also an extra, it's safer for people down there. Now the reform has a way and this will be more clear I think in a few slides that you can bring a case that you're going to face a massive bank run, you don't need a lot of physical dollars to dollarize bank deposits. This is not to say this is not something to pay attention to, but there are still ways to deal with this and move forward if you want to dollarize. Okay, moving to currency, right, paper money. There are different ways to deal with this. In Ecuador, dollarization was compulsory. You have nine months to change your secrets to dollars. After that they lose validity. So the central bank in Ecuador has to go and facilitate for you to change the secrets for dollars. In El Salvador the dollarization of the currency circulation was optional. The solace, the colonists I'm sorry, they don't ever lose validity. You want to keep your pesos, keep them, no one else. You don't have to change them for you. If I'm in Argentina and I dollarize the currency circulation this way and I'm the central bank I may say I'm not dollarizing the pesos in circulation I don't have to change them for you. You want to dollarize, what do you do? Make a bank deposit, pay taxes. So as a central bank you don't need to have the dollars to change the pesos in circulation. And you can say well we're going to start with El Salvador way and do it optional and after the number of months let's say one year we're going to see the currency circulation falls below a certain threshold and if it does then you transfer to an Ecuador case and now you have another year let's say to change the remaining pesos to dollars. This gives you two advantages a few others but two important are one the central bank is bankrupt as I was saying before so now you are delaying for the year or the time you choose and give the central bank time to collect dollars to make that change. The other thing to achieve is that you reduce how many pesos will have to be changed for dollars. So let me show you a couple of graphs. This one is tracking the evolution of currency in circulation in Ecuador and El Salvador does Ecuador remember that they had nine months to change the supers and that's the time frame where you see the currency circulation fall into low levels. Then you have El Salvador where it was optional and it took around two years for that colonists in circulation to disappear. The remaining amounts you have it probably bills that got lost damage and who knows where they are but accounting speaking they still exist somewhere. This graph is what happened to Ecuador central bank once they announced polarization. So these are your central bank reserves in Ecuador they dollarize in January 2000 so that's the second line. This line is currency in circulation in Ecuador and you see it's going down as they dollarize the currency circulation but you don't see reserves going down. The postings go up. So how they dollarize a big proportion of their currency circulation as I said before go to the bank. The money going back to the bank so the central bank is not facing a loss of reserves. So central bank liabilities again we went through the second part of the realization the currency in circulation and as you can see you don't need a massive amount of dollars. Central bank liabilities this is a very Argentine particular problem. The central bank is insolvent. It needs to be recapitalized. There are different ways to do that. Who owns the Argentine central bank is the owner. So how can the owner of this firm bring more capital to the firm? One is you issue debt. Argentina issues sovereign debt. They sell the bonds, they get the proceeds, send them to the central bank. This is transparent, easy to understand. We can see what's going on. The problem, no one wants Argentine debt. So not doable. Option two, the Argentine government decides to expropriate all the assets. A few years back the government decided to expropriate all the private retirement funds. All your 401Ks, IRAs, that's mine now. Thank you for saying yes to my not question if you are willing to give them to me. So the Argentine government has a big financial portfolio that is sitting at some office used politically if you want. So one option is to take that, sell it in the market, deposit, send it to the central bank. Again, easy to see transparent, understand what's going on. A lot of those financial instruments you had to deal with them in Argentina they're not international, you know, financial instruments and the Argentine financial market is like this big. So you cannot sell that in the market. It's too big. The market is not big for you to absorb this. You're going to be a large disruptive effect in the secondary market. So this can be even if you can't do it. So what do you do? You go fancy. Structure financial solution. The upside. This is the financially speaking best way to go around this. It's the cheapest way. The downside is the most complicated part of the proposal. It makes it confusing. I even had discussion with the Argentine economy that, you know, we're trying to talk how you discount the cash flow in a bond and we cannot just get around that, right? So this requires using instruments that are not typically present in Argentina. So I'm going to explain this the easiest way I can. I don't want to go into the details because that's boring also for me. But it's interesting to see how it works. It's not that, you know, that crazy. So we have the Argentine Central Bank where you have your monetary assets that will be reserved, very low, and then you have monetary liabilities. That's basically the base money. And just from now, we talk about the bank deposit, the currency circulation. We're going to focus on the orange part. So in the financial asset, you will typically have Treasury bonds that you go and sell in the open market but not in Argentina because those are non-negotiable bonds. The Central Bank cannot sell those bonds. It has to sit on them. And so the Treasury, instead of paying off those bonds, they roll them over and they have to stay at the Central Bank. On the liability side, because the Central Bank in Argentina cannot sell Treasury bonds to withdraw money supplied from the market, they have to issue their own bonds and sell them in the market. Those are those equity bills I was mentioning before. And that's the, on the liability side, the orange part. So we need to shut down the Central Bank. This proposal is working with setting down the Central Bank. We don't want to leave it open. So we need to liquidate this. So the first step and I'm going to separate this into steps to make it conceptual easy. The Treasury is going to take those bonds. The Treasury is the issuer and it's going to swap them for the same amount, hopefully larger duration of bonds under international law. So your typical sovereign bond and these bonds are never going to hit the market. These bonds are going to be relocated in an international trust or a special purpose vehicle if you want. Sitting there. Now you want to diversify as much as possible the exposure to Argentine risk in this trust. That's only so much you can do. But we can diversify the cash flow that this trust is going to be collecting. So the government is going to send to this trust maybe other assets and for example. So maybe I'm going to some of the exports, taxes I collect, that's what's going to go to the trust. Fresh dollars to this entity. Those financial instruments I mentioned the Argentine government has after the appropriation of the private funds send them to the trust. And now you're collecting dividends and coupons that don't come from the Treasury. If Argentina sells the 5G network those projects can go to the trust. I mean, you can come with examples. The point is to diversify that cash flow as much as possible. So we send that to this trust as well. Now we have these liabilities on the central bank and they are going to be re-denominated and the issuer will be the trust. So you find a bank and I have this short-term peso bill now it becomes a short-term dollar bill like a commercial paper. So now you can proceed close down the central bank I will have me drink that day this source of high inflation for years be done. Okay, so once you have that you can insert some extra tools try to reduce the risk of this trust because you have someone who is issuing these short commercial papers who are sitting at banks. You don't want to default those you need to keep paying them. And now the issuer, if it's international entity whose income depends on Argentina so you can add a couple of things these are pretty common but to give you an idea of how you can start to play with this instrument you can have a first loss guarantee you can have a backstop facility so if the market price commercial papers of these dollar papers falls too much, someone 16 and push the prices up. This trust default someone comes in and pays for them so you start to protect that risk with a limit but as much as you can you cannot do this in Argentina this is one reason why we move this outside Argentina jurisdiction. If Argentina is dollarizing if you create these additions then the market value of this instrument needs to increase and you benefit from evaluation upside. Okay fine so what is this? Now what? Now you have a computer. The computer says every dollar that comes to this trust through all these assets has to automatically be used to pay off this debt that was coming from the central bank so we have hundred dollars of these central bank liquidities that expire and I collect twenty dollars, I pay twenty dollars off I roll over eighty. Next year I get paid fifteen dollars, I pay fifteen I roll over the remaining amount until I pay off all of them so as time goes by those liabilities on the trust start to go down and down and down because you have excess collateral you can use that to attract dollars and send that to Argentina as I was mentioning before to help with the banks so once you are done and there is nothing else to be paid off this automatically self liquidates all those assets go back to Argentina and you just dollarize and create the largest reduction in Argentine debt in history without defaulting they should be exciting for any presidential candidate but none of them bought it so ok so this is the most complicated part of the reform this is how we go around the problem that commercial banks are sitting on that debt and we cannot default that and we need to find a solution where we don't have dollars to buy them outright so as I was saying before and as you probably know Argentina is going through difficult times Argentina is a country with long-term fiscal deficits that's the case now as well and you may be concerned that now that you move those bonds treasury bonds from the central bank to the trust the government cannot roll them over anymore they need to pay and those dollars become the source to start to cancel off the central bank bills so given that the treasury is in deficit is basically in default you are going to put all that extra expenses on the treasury how you deal with that one of the advantages of going this way is that you can play with the timing of those payments so one way to deal with this fiscal cost is that you when you change those bonds at the central bank to the new ones you impose a grace period ok these are the new bonds the same amount of debt you postpone when the bond starts to pay and you buy time for the treasury to fix their own situation another way is to extend the duration of the payments with the new bonds so those are your original payments now you swap the bonds and you make payments go less per year but for a larger number of years or you make a combination of both the point is that you have a variable you have this to help the treasury solve their problems without sending them bankrupt by doing this ok so how long it takes to do all this for the public once you change the unit of account once you say you are dollarizing you say your your dollarization rate just your dollarize yeah maybe you have pesos in your wallet but now your country currency is the dollar you are already standing on the dollar done for the government it's a little different you dollarize the bank accounts that's fast currency circulation may take nine to twenty four months if you take Ecuador and El Salvador cases as you know as benchmarks changing or dollarizing the central bank that can be longer maybe you take four years to pay off all those bills, debt, bonds that the central bank has it doesn't matter the point is once you announce your dollarization with central banks and so on it doesn't matter for the public at large so this is not a long process when Ecuador dollarizes I think it's announced on a weekend that Monday interest rates collapse money starts to flow to the banks probably the government was still trying to figure out how to do this the announcement itself was a game changer ok there are a number of things that needs to happen other than dollarization dollarization is not trying to substitute or replace other reforms dollarization is not sufficient but a necessary component if you want to really change Argentina and it's also gonna help you carry the other reforms so one of the things we talk about in our book is a bank reform to give you an example think of Panama a very internationally open and integrated financial system other things that needs to happen whether you dollarize or not you need to have other structural reforms you need to balance the budget you need to change your labor regulations you need to do a lot of things even if you don't dollarize you need to correct your exchange rate this happened already so this bullet is solved but even if you don't dollarize you will have to depreciate the peso that's one of the first thing that the new government did you may need to have a sovereign depth swap or renegotiation some of that is already taking place so all these problems are not reasons to dollarize because you have to deal with them one way or another okay so that's a summary of how you do this there are different ways to dollarize that's the way that we proposed it in our book so what's going on these days during the presidential campaign the topic of dollarization became very intensely debated what we presented is to more than one presidential candidate the current president Javier Millay he announced in the presidential campaign that he wanted to dollarize he said he wanted to do it following this proposal so this was highly debated but then soon before the elections the plans changed so Argentina it's today not dollarized I get a lot of questions what can happen so let me tell you where we are now so you can have in principle three scenarios for anyone who was going to be a new government you dollarize soon or as soon as you can you dollarize later meaning you want to balance your budget first you want to pass some reforms and then you dollarize or you try to keep the peso alive those are basically the three scenarios and keeping the peso alive can mean different things different forms trying to do that whatever those are those are your three broad strategies you can follow so we know that early dollarization is off the table so now we are between are we going to see a later dollarization or are we going to see trying to keep the peso alive and it's very hard to tell because if you look at this from my view what the government is doing that's consistent with trying to keep the peso alive so if I follow the facts it's not starting out to me what the government really wants to do there's another scenario if Argentina dollarizes how can that happen one scenario they actually do these reforms and they dollarize later by conviction that's what the government wants to do they manage to do it they do it and that was the most likely for me and keep in mind we started to work on this book in 2020 way before Millay was even presidential candidate anything like that is that what is pushing Argentina to dollarize is Argentina's economic conditions Millay can be same publicly every day the dollarization is the worst idea in the world it will still be on the table whereas Argentina has been talking about the dollarization for years so the other scenario is more similar to Ecuador's case Argentina walks into another very serious crisis because they're not trying to minimize the likelihood of failure like we were saying in the first place and the only way out they find is dollarizing however they can at the last moment and that's the reason to have a proposal written in the first place we don't want Argentine Congress to innovate dollarization overnight in the middle of an emergency may not be the best so how do you minimize the errors of improvisation have a proposal out there ready to serve as a guideline that was the initial motivation behind this so if Argentina dollarizes my sense is more likely going to be this like this case this year, next year, five years from now, ten years from now I don't know but there are not many monetary regime options out there that can function unless you have a very serious credible institutional reform that's what I have I'd be happy to talk about this or answer any questions I can and thank you for being with me