Hello Argentina: A word to the wise, dollarize

By David DeRosa

NEW YORK (Bloomberg): The cat is out of the bag in Argentina. Central bank President Pedro Pou wants to give up the peso and dollarize his country.

He told reporters last Thursday the bank wants to "build upon the success of our current monetary policy to reduce the perception of risk in our country." Right! Spin city in Buenos Aires. Maybe the truth is that Pou and the central bank are running for their lives ahead of a collapse of neighbor Brazil.

Still, dollarization is picking up momentum. An unnamed International Monetary Fund official last Friday said replacing the peso with the dollar is "an interesting idea" worth studying, according to Agence France Press.

Let's consider how such a plan might work. The Argentine legislature would have to approve the repeal of the 1991 so- called "convertibility law." Now, this is just me thinking and writing out loud, but I suppose the congress would decree that all debts, public and private, would be denominated in U.S. dollars, henceforth. The dollar would become the legal tender of the land. Sounds simple enough.

But what about the currency, meaning the peso notes and coins? The central bank could try to finesse the conversion by simply saying the old bank notes are "private label" dollars backed by reserve assets. That might work for a while at least.

Sooner or later, the central bank will have to produce the real McCoy, so to speak. If the Argentines are serious about dollarizing, they are going to have to buy back all the peso notes and give out dollars to the general public in exchange.

But where would Pou physically get the dollars? One possibility would be to use the currency board's much trumpeted dollar assets. On the other hand, Argentina might want to hold onto the reserves in case some day they want to go back to the peso. So my guess is that they are planning to hit up Washington to send them a few C130 airplanes with fighter escort, full of currency on credit. Either way, it's fun to wonder how Argentina might arrange for physical transport of so many U.S. dollars.

Argentina and U.S. Federal Reserve officials held preliminary talks last Thursday on Pou's dollar plan. The practical reality of Argentina adopting the dollar is that its central bank would give up all control of domestic monetary policy. In effect, Fed Chairman Alan Greenspan would run monetary policy in Argentina.

Pou has thought about this a great deal, it would seem. He wants a formal agreement with the U.S. wherein his central bank would get interest on its dollar reserves. He also wants to reserve the right for the central bank to continue to operate its bank discount window (so local banks can borrow at a discounted rate of interest).

Pou thinks it would take at least two years to work out details of a dollarization plan. The problem is he may not have two years. In fact, he may not have even two weeks.

Take a look at what else Pou said last week: "There are three dominating currencies in the world: the dollar, the yen and the euro. Latin America is the area of influence of the dollar."

By extension, is Pou saying that all of Latin and Central America might want to give up their currencies and adopt the dollar as well? Isn't this convenient for Washington, coming at a time when the European ministers are trying to get Asia's central banks to trade their dollar reserves for euros!

It's worth thinking about, the idea that North and South America -- excluding Canada -- might be cooking up a currency union of its own. Argentine President Carlos Menem is reported to be a supporter of the dollar plan for all of Latin America. Note that no binding fiscal agreement, along the lines of the European Monetary Union's famous "stability pact" would be required.

How far will this go? The heat is on now because of the adverse implications that Brazil's predicament has for Argentina. At the rate things are moving, we could find Argentina on the dollar very soon. Or maybe Brazil will get lucky and the currency crisis subsides. Don't count on it, but if that happens, it will be interesting to see who wants to dollarize.

Whatever else, this much is clear: Panama is owed an apology. That country effectively dollarized years ago and has endured snide comments that it isn't important enough to have its own currency.

The writer is president of DeRosa Research and Trading and an Adjunct Finance Professor at Yale School of Management. The opinions expressed here are his own and don't necessarily represent the judgment of Bloomberg LP or Bloomberg News.)