Buenos Aires — Nicolás Cachanosky is the co-author, alongside Emilio Ocampo, of “Dollarization: A Solution for Argentina,” one of the proposals preferred by the libertarian presidential candidate, Javier Milei.
Cachanosky, who has resided in the United States since 2009, is a professor and researcher at the University of Texas at El Paso and also collaborates with the American Institute for Economic Research and the Friedman-Hayek Center at UCEMA. He specializes in finance, economic cycles, and monetary policy.
During a conversation with Bloomberg Línea, he emphasized the feasibility of initiating a dollarization process in Argentina starting in 2024.
The following conversation was edited for length and clarity.
After the primary elections, you wrote that dollarization is neither “magic nor a panacea, but rather a major surgery for a seriously ill patient.” What sets today’s Argentina apart from Uruguay in 1990 or 1968, or from Peru, which faced significant inflation issues in the ‘70s, ‘90s, and ‘80s, and why do you believe Argentina has lost the ability to achieve what these countries have?
The proposal to dollarize the economy was developed in collaboration with Emilio Ocampo, starting in 2020. However, I am not affiliated with Javier Milei or any current political movement in Argentina. Therefore, I request the audience not to interpret anything I say as representing any candidate. Why opt for dollarization? One motivation is to seek not just a quick fix for the inflation problem, something that lasts for a few years or a presidential term, but a fundamental and enduring solution. Argentina has experienced 60% annual inflation from 1940 to the present, indicating a deeply rooted and highly institutional problem. Another consideration is the high cost Argentina could incur in the event of a new currency or monetary crisis. The stakes in terms of poverty are very high if a monetary regime fails, hence the proposal’s priority is to reduce the probability of failure. We are assuming you have only one shot left and cannot afford to miss. Therefore, the preference is to err on the side of a reform that includes extra safeguards to prevent a new populist movement from politicizing the Central Bank. Why not a solution like Uruguay or Peru, for example? Due to the lack of institutional and political credibility in Argentina, which is essential for the success of any monetary regime. Two conditions must be met for a monetary regime to function: technical consistency and political and institutional credibility. This is what we see as lacking in Argentina more than in other countries in the region. I’ll provide two examples. One is what happened in 2001 with the law on deposit inalienability. The same Congress that approved it reversed it shortly after. Another recent example with Cambiemos was the famous December 28th, where they intervened in their own Central Bank, which was run by Ivy League economists from top universities. This illustrates that even in a government like Mauricio Macri’s, Central Bank independence is not real because it is set aside when it truly matters. Having Central Bank independence when everything is going well is easy. The key is for it to be maintained when things are not going well or when you have a bad government. In that context, there are limited options on the table, leaving dollarization as a practical choice. What sets dollarization apart from other monetary regimes is its reduced dependence on local politics, making it more robust and credible. It works equally well with both competent and ineffective governments, which is precisely what Argentina needs today.
Would something similar to [Roberto] Campos Neto resisting Lula’s pressures be utopian for Argentina?
There are two issues to consider. One is the persistent inflation in Argentina. Except for the ‘90s, Argentina has always had high and volatile inflation, at least over the last 80 years. The other issue is institutional degradation. It’s not credible for any government to promise Central Bank independence. If it’s not credible, it won’t be effective, and therefore, it won’t last. It’s also very risky in case it fails. It’s worth considering something credible and enduring that allows you to move forward and implement other reforms once and for all. While dollarization does not seek to replace other reforms, it aims to provide the space to implement them. However, with this level of triple-digit inflation, if you don’t solve it quickly, you won’t have the political power to make progress. You need an effective, credible solution. Otherwise, as is the case in Argentina, you take one step forward and two steps back.
You recently mentioned that the most appropriate counterfactual to analyze from Ecuador’s dollarization would be, “What would have happened under [Rafael] Correa without it?” But why do you believe that a more authoritarian and populist government in Argentina couldn’t break dollarization, considering the precedent of 2001 and the asymmetric pesification?
The fundamental difference with 2001 is that it was an exit from a convertibility regime [one-to-one peg to the US dollar for the peso], and people were still using pesos. If you want to exit that system, you break the exchange rate peg, you exit convertibility, and you’re done. Of course, in 2001, the exit was poorly executed, right? It involved default, tax increases, and so on. That’s why it was so severe. Now, if you are dollarized like Ecuador, the problem is that you don’t have your own currency to fall back on. Sucres no longer exist, and in Argentina, pesos wouldn’t exist either. So, you would have to go to people’s homes, take dollars from their pockets, and impose a currency they don’t want. It’s much more challenging. Correa had more political power than the Kirchners. He was able to amend the constitution, essentially do what he wanted, and he couldn’t openly state that he would de-dollarize, even though he tried with his electronic money scheme. It didn’t make progress. Therefore, one of the strongest safeguards in dollarization is that the political cost of undoing it is high. Zimbabwe can de-dollarize easily because they have their central bank. So, if you dollarize and shut down your central bank, it’s an extra safeguard that reassures people that their deposits won’t be at risk. The functions that a central bank would have in a dollarized country can be relocated to other institutions. You don’t need a central bank.
Which scenario would be riskier in an economy with an out-of-control deficit, having its own currency or being dollarized?
Dollarization doesn’t guarantee fiscal balance, it doesn’t guarantee that you won’t default, and it’s not in itself a comprehensive fiscal or electoral reform. It doesn’t ensure that you won’t choose a populist government again. Its aim is to enable you to implement reforms. You have to stop worrying about what happens with inflation to be able to focus and have the political power to move forward. If you look at Ecuador, especially under the government of Correa, you can see that public spending increased, and they defaulted in 2008, alongside the global crisis. We never denied this. However, the costs that Ecuador incurs in those contexts are lower than what Argentina suffers. The first example is that Argentina stagnates and is heading toward hyperinflation, while Ecuador’s economy stagnates but maintains price stability. The absence of hyperinflation for them is not a minor issue at all. The second example is that when Ecuador defaulted, in 2008 and 2020, you can see that the country’s risk premium, the cost of Treasury debt, increased. However, for the private sector, access to credit and the cost of credit were not affected. Therefore, there’s a kind of disconnect between what happens to public accounts and the cost it imposes on the private sector.
And what happened in those defaults and external shocks with foreign and domestic investment?
I should check the data, but you don’t see, neither in 2008 nor with COVID-19, that economic activity in dollarized countries like Ecuador, El Salvador, or Panama was more affected than in Argentina. During the 2008 crisis, which is a nominal shock, theoretically something a central bank can manage, real GDP in Argentina fell by almost 6%, while in Ecuador, it remained within a positive range of 0.6%, in El Salvador, it dropped by 2%, and I believe Panama also maintained positive growth. However, if you have an inefficient central bank like Argentina’s, you’re not managing external shocks. You don’t have the central bank of Switzerland or New Zealand. If that were the discussion, of course, but it’s not feasible. In the prologue of the book “Dollarization in Ecuador” by Jamil Mahuad, which was written by Domingo Cavallo, Argentina’s former Minister of Economy, there’s an interesting passage. Cavallo says he has no doubt that if it weren’t for dollarization, Ecuador would have ended up like Venezuela. So, dollarization is an institutional reform, not just a monetary one. If that institutional protection prevents you from ending up like Venezuela under the Chávez-Maduro regime, it’s also not a minor contribution.
So, your conclusion with Ocampo is that the trade-off is worth it? That it’s worth sacrificing the possibility of growing at Chinese rates in exchange for lasting stability.
I don’t know if it’s sacrificing the opportunity to grow at Chinese rates. Think about it, if you implement a credible dollarization, well-designed and well-implemented, show progress on the fiscal front, labor market reforms, trade reforms, regulatory reforms, the whole algorithm that Argentina needs, the growth potential is enormous. Consider the estimates of the amount of money that Argentines have in safes or under mattresses, so to speak, that could return to the banking system and therefore finance investments. If you look at another statistic, in terms of GDP, the amount of credit that banks provide to the private sector in Brazil or Chile, that expansion of financing for the private sector can be three to four times larger. There is a strong potential for short-term expansion if you implement it correctly, do it well, and don’t leave it half done, and so on. So, I don’t necessarily see that you are sacrificing the opportunity to grow at good rates.
So, you reject the criticism that dollarization prevents growth at high rates.
It’s a myth, because what you have to look at is where you are today and where your long-term equilibrium is. If, in the process of dollarization, you implement institutional reforms that give you higher long-term income equilibrium, you will have an inflow of capital. The case of Ecuador is interesting because of the counterfactual you mentioned. The ideal counterfactual is what happens to a dollarized Ecuador, which is the real world, versus what happens to a non-dollarized Ecuador. When those estimates are made, the results show that dollarized Ecuador fares better than non-dollarized Ecuador. Despite having Correa, external shocks, and so on, GDP growth is higher. And that’s the exercise Argentina should do. What is my growth potential if I continue as I am now, versus my growth potential if I implement this reform, which is one of the most profound you can undertake?
Can you explain briefly why you believe that the process of dollarization can start in 2024?
It’s a lengthy process because in Argentina, you have to dollarize three things: bank deposits, currency in circulation, and the Central Bank’s liabilities, the famous Leliq notes, to put it briefly. And each of these different liabilities can be dollarized in different ways. If you look at when and how Ecuador dollarized, they did it in a very complicated situation. They were emerging from a banking crisis with a corralito (deposit freeze) from one or two years earlier. In other words, they dollarized almost in the worst of circumstances possible, and they were able to do it. So, you don’t need ideal conditions to dollarize, although it would be ideal to have them. That’s why it’s important to have a well-thought-out proposal to avoid improvising at the last minute in a rush. The other reason why it’s potentially possible to dollarize is that you don’t need as many dollars as critics suggest. The famous calculation of the monetary base plus Central Bank liabilities over reserves is a number that is biased upward; it’s an exaggerated number. First, because part of the dollarization can be done voluntarily by the market. For example, people can deposit the cash they have in banks, which gets dollarized when it becomes a dollar deposit, or they can use it to pay taxes, which the government then provides in dollars, so it becomes dollarized. In these cases, it’s not the Central Bank that has to go out and buy that cash. Then, the calculation of the monetary base, liabilities, or reserves assumes that dollarization is a spot transaction, like “Give me all the pesos, and I’ll give you the dollars.” In reality, if the Central Bank has enough reserves, you can think of it differently, as a gradual process. This is where the Monetary Stabilization Fund (MST) is essential to determine what to do with the Leliqs (Central Bank short-term notes). In summary, the process works like this: The Central Bank has a portfolio of bonds, non-transferable securities, and temporary advances. Suppose that portfolio is worth 100. The Treasury exchanges it for 100 in debt, issuing new bonds worth 100 in international law, so the debt amount remains the same. That portfolio of bonds, instead of going to the Central Bank, is placed in a trust in an international jurisdiction, beyond the reach and control of the Argentine government. It isolates it from Argentine risk. That trust has these new international bonds as assets and may receive other contributions from the Treasury. An example would be a portion of export taxes, which, since they cannot be eliminated today, go directly to this trust. So, in the assets, the trust has the bonds that came from the Central Bank, exchanged for these international bonds, and other contributions that the Treasury may make. These assets don’t need to be sold in the market. Nothing is sold in a fire sale, no bonds are dumped in the market. Instead, the trust starts to collect coupons, payments, and so on. In the liability section, you have what the Leliqs used to be, which becomes short-term dollar-denominated debt, like commercial papers. So, every dollar that enters the trust is automatically earmarked for paying off the Leliqs. This scheme has an advantage in that you don’t have to rush to buy all the commercial papers on day one. Another advantage is that it allows you to play with the maturity dates, which is important given the country’s fiscal situation. You can say that the trust initially receives part of the taxes, whatever the Stability Guarantee Fund generates in dividends and coupons, but these bonds that the Treasury exchanged with the Central Bank start paying in one or two years. And if these bonds need to have a longer maturity, like six, eight, or nine years instead of four years, you can adjust the timing to avoid choking the Treasury. Afterward, you have to carry out a fiscal reform. And this has a fiscal cost because the non-transferable securities in the Central Bank, which the government rolls over but doesn’t pay, now have to be paid. Another advantage is that the dollarized replacement of the Leliqs can be traded in the secondary market. So, if you’re a bank in Argentina and you don’t want to hold them or need cash, you can sell them. What happens when the MST finishes rescuing all the Leliqs? It automatically liquidates, and all the assets return to the Treasury, which means a cancellation of sovereign debt.
To replace the Central Bank’s liabilities, including the monetary base and interest-bearing liabilities, currently around US$35,000 million at the parallel rate: How much of that would you need to have on day-one to start the dollarization process?
On the day you start dollarizing, you need dollars to replace the reserve requirements, some cash dollars that you bring to withdraw from banks, and so on. Then you need dollars to start paying the trust so that it can begin redeeming the Leliqs. You might have the option to choose when you start paying. Suppose you dollarize in January 2024. You say, “Well, the Treasury is in bad shape, so the first bond will mature in 2026,” giving the Treasury two years of grace to adjust and obtain the dollars to start paying off those bonds. What happens during those two years? The trust is receiving dollars from export tariffs, dividends, and coupons from the Sustainability Guarantee Fund (ANSES) or any other income that the Treasury may want to provide temporarily until the large payments from those funds start to flow in.
This week, you clarified the issue of the Central Bank’s non-transferable securities, which many analysts believe have zero-value. You propose that when these securities are exchanged for new bonds, in a process complemented by a series of fiscal reform proposals, these bonds would appreciate, so we should consider the future value of the asset rather than the present value. Isn’t there a problem there, a risk that these bonds might not appreciate if the market remains so averse to Argentine risk?
As you correctly pointed out, many analysts often say that non-transferable securities are worth nothing. This expression is very common in Argentina, and I have never taken it literally. These non-transferable securities are bonds that represent a promise of cash flows. If you look at the Economy Ministry’s quarterly report, you will see the cash flows and coupons associated with these non-transferable securities. So, I cannot sell them on the market, but how much would they be worth? What would be the mark-to-market value of these bonds? You value them as you would any other bond. You take the cash flows and discount them at the discount rate applied to Argentine bonds, in the same currency, for similar bonds. That doesn’t amount to zero. Argentine bonds in the market trade at a significant discount, but not at an infinite discount. In fact, when the Central Bank in Argentina valued non-transferable securities at market value, it did so using this methodology, and it did not result in a zero valuation. The fact that the government rolls over non-transferable securities does not mean they are worth zero because many bonds in the market are rolled over and do not automatically become worthless. But let’s assume they are worth zero hypothetically. It doesn’t matter because in this process, you take non-transferable securities and exchange them for bonds that trade in the international market. Therefore, those bonds do have value, even if you don’t sell them on the market.
But that does affect your payment capacity, right? Because their not currently priced in as would be the case with foreign-law dollar-denominated bonds.
It does have a fiscal cost. You can’t roll them over anymore; you have to start paying them. No monetary reform will be free. But the point is, how do you rescue the Leliqs without defaulting or implementing a Plan Bonex? They have to be paid. There’s no way around it. Ultimately, it’s debt we have due to the Treasury’s deficit. The Treasury is the one that needs to take responsibility for it, not the depositors, telling them, “You know what? I won’t pay you; I’ll exchange it for another bond.” Now, the valuation issue you mentioned, that assets can appreciate, is important because this scheme is designed to be implemented by a new government that wins the elections, has credibility, and is serious about implementing reform. A regime change that reduces country risk. What level of country risk can you assume? A conservative one, by Argentina’s standards, would be what we had before Alberto Fernández’s government, around 5 or 10 years before he took office. Let’s say more than 1,000 basis points. It’s enormous, but with those levels, the numbers work. Now, what matters to rescue the Leliqs is not so much the bond price because you’re not going to sell the bond. It’s about the cash flow it generates. How much will that bond entering the trust pay to subsequently go and cancel the Leliqs? In a hypothetical scenario, you might say the trust administrator sells some bonds to the market, but the concept is how Argentina dollarizes with what it has without having to flood the market with bonds. It collects payments, and these bonds that leave the Central Bank without going through the market go to the trust. When the process is complete, they return directly to the Treasury. In principle, there’s no need to put them on the market. It’s not that the price won’t matter at all, but it’s not the most relevant aspect; the critical factor is the cash flow it generates. Just to sum up this point on non-transferable securities.
In a hypothetical exchange, how do you issue new bonds at better parities than what you have today?
You don’t need to because it’s not a bond that you issue and then sell in the market. We’ve seen this before during Federico Sturzenegger’s administration, where the Central Bank gave non-transferable securities to the Treasury and received bonds in return. These are bonds that never go through the market. In principle, the bond exchange is for bonds with the same nominal value and the same present value of cash flows. But you can extend the duration. Extending the duration has two benefits. One is that it gives the Treasury some breathing room so it doesn’t have to quickly pay off the non-transferable securities, which it couldn’t afford. Second, if you have a scenario where this reform manages to reduce country risk, it maximizes the increase in asset prices. This gives you a benefit: the over-collateralization of the trust increases, allowing the administrator to use that excess collateral to obtain cash if needed for withdrawals in Argentina or if they need to sell an asset for some reason, they can do so at a better price. But the core, the central point, is the cash flow it will generate.
The funds that would enter this trust are hedge funds, high-risk funds, what some here call “vulture funds,” right? What risks do you see in involving these types of players?
It depends a lot on the conditions under which you will dollarize. Argentina is obviously in a critical situation, and the Central Bank is practically bankrupt. So, one of the ideas of the FEM, this trust, is to create an entity that has a better risk profile than Argentina. So, I don’t know what funds Milei has or doesn’t have, what the agreement is, or if there’s an agreement, to be honest. I don’t have access to the details. But one option is to say, “Look, I’m worried that in this process, if there’s a deposit run, the banks will have to massively sell the commercial papers, and that could be a problem because the market is not big enough to absorb them at a good price. Well, maybe there’s an investment fund that sees an opportunity here and says, ‘You know what, I’ll buy the commercial papers, take them away from the Argentine banks, and keep them. I see that this is consistent, that the rate will drop. Therefore, I have a spread on which to make a profit.’” Because once the trust starts collecting cash flow, it cancels the commercial papers, no matter who holds them, as they operate freely in the secondary market. And what this does is somewhat clean up the balance sheets of Argentine banks if you will. The participation of this type of funds doesn’t necessarily mean that new debt is being issued. These funds can buy stocks or existing bonds. It’s not the issuance of new debt; it’s a transfer of debt from one party to another. It’s a cleaning of debt and, of course, has a fiscal cost, as you mentioned.
And does the cost also have to do with the over-collateralization? That if things go wrong, the cost would be quite high.
Over-collateralization gives you a kind of cushion if the discount rate doesn’t decrease as much as expected or if it increases for some reason. The more excess collateral you have, the safer the trust will be. If you’re dealing with the trust, you’re not dealing with Argentina. The idea is to isolate the country risk from this trust as much as possible.
In Ecuador, they continued to conduct monetary policy indirectly through bond trading. Is that something you consider in your proposal?
Even when you dollarize, there are still mechanisms to deal with financial markets. It’s not that you leave nothing on the table. Given the institutional risk I see in Argentina, as I mentioned earlier, my recommendation is to close the Central Bank. What you can still have without a Central Bank, as you see in Panama and could be replicated in Ecuador and El Salvador if it weren’t for their Central Banks, is a liquidity fund to manage short-term liquidity needs. And that fund can be managed by a financial regulatory entity, by a consortium of banks; it can be managed in different ways that don’t require the Central Bank. Therefore, you can create that fund without any problem. You can also have access to lines of credit with international banks, as is the case in Panama. It’s not that if there’s no central bank, nothing can be done.