IMF Conference

Thursday, June 24, 1999
International Monetary Fund
700 19th Street, N.W.
Washington, D.C.

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Governor, Central Bank of Mexico.
Miguel Kiguel, Chief of Cabinet of Advisors and Undersecretary of Finance, Ministry of Economy and Public Works and Services, Argentina.
Jeffrey A. Frankel, New Century Chair, The Brookings Institution and Harpel Chair, Harvard University. He was until recently, Member, President's Council of Economic Advisers.
Eduardo Borensztein, Division Chief, Developing Country Studies Division, IMF Research Department.

MODERATOR:

David Goldsbrough, IMF Deputy Director, Western Hemisphere Department.

PROCEEDINGS

MR. CHAIRMAN: Gentlemen, distinguished speakers, welcome to this session of the IMF's Economic Forum.

This afternoon we are going to discuss what is generally referred to as the issue of full dollarization by which we mean all the issues involved with the adoption by one country of another country's currency as its official legal tender currency.

We refer to it as dollarization but, of course, it could involve the adoption of another currency, the euro, the yen, and any other major currency. But I think what we're going to discuss this afternoon is particularly these issues as they refer to Latin America. So, it's really a question of the potential costs and benefits of adopting the dollar in a broader setting.

Now, some of these costs and benefits are quantifiable. Those are typically the costs of giving up seignorage, earnings associated with currency, and on the benefit side you have potentially lower spreads associated with the elimination of risks of devaluation.

Some of the costs and benefits are less quantifiable but are probably much more important in the longer term. Those would range from the potential on the cost side, any costs associated with a loss of monetary independence, ability to respond to asymmetric shocks by a more active monetary policy, for instance. And on the potential benefit side the longer term benefits of increasing economic financial integration into a broader regional and global economy.

So, we have a distinguished panel of speakers today who will discuss some of these issues and each will bring to it their own perspective.

Let me briefly introduce them, I guess, in the order in which they are going to speak. Our first speaker will be Jeffrey Frankel, who is soon to be professor of economics at Harvard, and until recently has been a member of the President's Council of Economic Advisors.

And our second speaker will be Guillermo Ortiz, who is Governor of the Central Bank of Mexico.

Our third speaker will be Miguel Kiguel, who is chief of the Cabinet of Advisors and Under Secretary of Finance in Argentina.

Our last speaker will be Eduardo Borensztein, who is a Division Chief here, in the IMF's Research Department and has been doing some thinking about these issues.

So, without further ado, let me turn the floor over to our first speaker.

MR. FRANKEL: The event that I was describing as remarkable and perhaps historic in Argentina in January was the report from the Central Bank to President Menem suggesting the possibility of dollarization in Argentina, full official dollarization and laying out a blueprint for how specifically it might take place.

This has given us something new to talk about. A lot of the issues of exchange rate regimes are pretty familiar textbook stuff, fixed versus floating rate, but this is really a new idea that a country as large and independent as Argentina might seriously consider giving up the peso and adopting the dollar not just in the private sector but as official, legal tender. It remains to be seen whether they'll go ahead with it, of course.

And elsewhere in Latin America this idea seems to be being taken seriously now perhaps for the first time and it has generated a lot of attention and interest even in this country.

Where it's coming from, of course, is the lesson that some have drawn from recent exchange rate crises in emerging markets over the last two years to conclude that pegs that are less than absolute are perhaps not viable in modern, globalized high-volume financial markets; that they can't hold up against today's international currency speculation. And, so, the only defense, at least, for some countries is to abandon their own money completely and to adopt the dollar as the official currency.

My view is that full official dollarization probably is a good idea for some countries in Latin America particularly countries that are quite small and open, let's say, some in Central America. It might even be a good idea for Argentina if the political willingness to give up all monetary sovereignty is truly there now. But I think there is a danger of exaggerating this trend.

A wholesale movement of all or most of Latin America onto the dollar, in my view, is not very likely and would probably be not well-advised at this point in history. My view is one still can recommend for many countries the intermediate regimes in between the extremes of dollarization and free floating.

And that in saying that I am taking exception to what has in a remarkably short period of time become a new conventional wisdom that these intermediate regimes are not defensible and that countries are all going to have to move to the corners of either firm fixing or free floating. And when I say, conventional wisdom, even in official circles, that proposition has been supported in terms that I find a little too strong.

Let me begin, before I turn to the Latin America case, by just covering some general principles on the issues of exchange rate regimes and fixed versus floating regimes. First, to be clear what we're talking about, there really is a whole range of regimes, of course, it's not just fixed versus floating.

In the flexible corner, we have free floating. And since no country, even the United States, floats completely freely, everybody intervenes at least somewhat, I suppose we should classify managed floating together with free floating as being in the flexible corner.

The intermediate regimes that we're talking about are basically four. Adjustable pegs, crawling pegs, basket pegs and target zones or bands and many countries, of course, have some combinations of the features of these different intermediate arrangements and those are the ones that have been declared to be an endangered species.

And then at the fixed corner, we have institutional arrangements that do not merely proclaim a fixed exchange rate but actually lock it in, in some way, to make it extra credible. The Currency Board that Argentina has, in my view, had considerable success with since the convertibility plan was adopted in 1991, and Hong Kong before it, and Estonia, and some other countries since then. And then the even more extreme step of full currency union in either the form where countries have some say in monetary policy, the European Monetary Union which has also worked, in my view, more successfully since January than many of us forecast it would a few years ago. And then the version that is under discussion today where you give up your own currency and adopt the dollar as your legal currency, but do not actually have input into the monetary policy of the country creating the currency.

We economists, of course, believe that life is always a trade-off. In this case a trade-off between the advantages of fixity and advantages of floating. Just to state it very succinctly, because there is a lot to be said on both sides, but in my view the two big advantages of fixing the exchange rate are: 1) to reduce transactions' costs and risks which discourage trade and investment; and, 2) to provide a credible nominal anchor for monetary policy.

And, of course, the firmer the commitment the more credibility gain there is. So, the idea behind dollarization is that it is the ultimate commitment that is virtually irreversible (although that's not literally true). The big advantage of floating exchange rates is the ability to pursue and independent monetary policy. As financial markets become increasingly integrated, the choice between monetary independence and exchange rate stability is becoming sharper and sharper. It used to be you could finesse this a bit with capital controls or frictions in markets, but it's becoming harder and harder. The choice is very sharpened.

But that is not the same as to say that countries must literally choose between those two corners. I think there is a danger of over-stating that. When it's said that all countries are going to have move away from the intermediate regimes, my view is that the optimal regime depends on the circumstances in question.

And I was pleased to see last Sunday in the report of the G-7 Finance Ministers that was released at the Cologne Summit, that it did explicitly say in there that the choice of regime depends on the circumstances of the country in question, which you would think would be pretty obvious, but it wasn't quite clear that everyone understood.

The characteristics, let me just quickly run through. First, the traditional characteristics that are familiar that should determine whether a country is a good candidate for a fixed or floating or in between: Size, openness, correlation of shocks, labor mobility, fiscal cushions, desire to have integration with major partners. And then I think now in light of recent experience we have to add some. Most importantly, the determinants of political willingness to sacrifice monetary sovereignty for the sake of stability, such as a past history of hyperinflation, and absence of credible stable government institutions or unusually large exposure to nervous international investors. These are the sort of things that give a country a sufficient fear of monetary instability that they are willing to make that switch.

And other items, I think, we have to add to the list are the availability of reserves, the strength of the banking system, and the existence of rule of law, particularly in the case of a Currency Board.

It would be foolish to talk about a currency board or dollarization as a cure, as credibility in a bottle, that will work for all countries regardless of institutions and regardless of political support. I mean, aside from all the economic pros and cons there is the point that up until now most countries have simply not been willing politically to give up the degree of sovereignty that is required to literally give up having an independent currency.

And I like to give the example of Israel in 1983, where the Finance Minister was actually considering giving up the currency and going on the dollar and when this news became public there was such an uproar that he was forced to resign.

Even in Argentina, we've heard people say we don't want to become an appendage of the United States like Puerto Rico. A cab driver was quoted as saying, that, sure, we'll go on the--Argentina will go on the dollar when the United States agrees to put Eva Peron on the dollar bill.

But, overall, what is striking is how seriously this is being taken in Argentina. And some say that Menem wasn't serious about this, that he did this to get political support and draw attention to himself in an election year. Well, how far have we come when that is even a viable strategy because in most countries, most of the time up until, now you would lose political points, not gain political points by having it known that you were considering giving up your own sovereign currency and going on the dollar.

Let me now consider the sort of pros and cons, should Argentina dollarize? First, from the viewpoint of Argentina, itself and then from the viewpoint of the United States. Of course, Argentina has already gone a long way towards showing that there is sufficient political support for monetary discipline to give up the independence under the convertibility plan. So, the question arises, is there anything to be lost by going further, by going all the way to giving up the currency?

I would say the traditional view is that there still is a modicum of independence that you would be giving up and that it would be a little surprising if a corner solution were the right answer, as opposed to an interior solution, which is so often the right answer from an optimization problem in economics. What kind of independence would Argentina still retain? Three kinds.

First, it could always abandon the currency board, even though that means changing the law. In theory they could do that. Second, they could peg to a different foreign currency. If the current spectacular U.S. monetary policy did not hold up in the future, they could switch to the euro or something.

And third, Argentina currently has what is sometimes called a quasi-currency board that there is still some scope for sterilization, some scope for cushioning, when there is a reserve out-flow. It doesn't have to be completely reflected in the money supply and in contraction.

But one of the central points I want to make is that recent experience suggests that whatever the advantages that Argentina and other Latin America countries have in theory with some residual monetary independence, in practice, it's not really there. They are not really able to use the tool of independent monetary policy effectively.

In part this is because there is sensitivity, tremendous sensitivity even under the current system to U.S. interest rates. Ask the question this way: When Alan Greenspan raises interest rates in the United States, what is the effect on the interest rate in the Latin American country? The big argument against giving up monetary sovereignty is that you have to suffer an increase in interest rates in your country even if that doesn't suit your economic conditions, your stage of the business cycle at that time and even if what would suit you would be an easier monetary policy.

Well, currently, the situation is worse than that. Currently, when U.S. interest rates go up, interest rates in the Latin America go up more than one-for-one. I did a OLS regression that suggested that when interest rates in the U.S. go up, Argentine interest rates go up by 2.7 basis points for every basis point increase in the U.S. on average.

In Panama, by contrast, which is the largest country in the hemisphere that is fully dollarized, interest rates do not go up as much as in Argentina. And on the other hand, in countries like Mexico and Brazil, interest rates go up by a lot more. So, it's somewhat paradoxical.

This suggests that if Argentina or any of the other countries went the full distance and dollarized, yes, the statistical fit to U.S. interest rates is very tight, but on average the interest rate goes up, at worst, one-for-one, and not more than one-for-one.

The point is that there is still a currency premium and a country premium built into Argentine interest rates. They have gotten some benefit out of the Currency Board but not the full benefit. If Argentina or other Latin America countries dollarized, the currency premium would disappear by definition. Yes, there would still be a country premium but perhaps a country premium would also diminish and would become less cyclical, less variable with U.S. interest rates.

The three different possibilities for the mode of dollarization that were built into the blueprint that the Argentine Central Bank submitted were first, bilateral negotiation with the U.S.; second, unilateral; and third, regional. In the bilaterally negotiated option is a proposal for a treaty of monetary association with the United States, where the Argentines might get certain things as part of an agreement. The one thing that they have not asked for at all, as I understand it, is voting rights on the FMOC, which is fortunate because I think it is unlikely that they would get it.

But the three things that they did ask for in January were seignorage, which is worth $600-to-$750 million in lost interest; second, access to the Fed discount window by Argentine banks; and, third, cooperation regarding bank supervision.

My view is that these are imminently reasonable things to ask for; my guess is that they are not going to get them anyway. That there is too much sensitivity. The U.S. is wary of incurring contingent liabilities and sufficiently wary of the sense of responsibility that it might refuse to enter, even into a symbolic treaty designed to give a stamp of approval to the plan but especially to actually give the seignorage which is pretty hard to explain to Congress.

So, then if that is right, the question is should Argentina do it unilaterally, and I think that perhaps if the political willingness is there that it might actually be in its advantage. That it might be gaining more in terms of credibility than it is losing by giving up whatever ghosts of monetary independence remains.

Pros and cons for the United States. Just very briefly, four benefits for the United States. First, if they don't get the seignorage, we do. So, that's one benefit. Second, enhanced ease of transactions with Argentina on the part of U.S. businesses and travelers; third, the increase in trade that stability and prosperity would bring about; and, finally, maybe some foreign policy benefits to spreading U.S. influence.

I have to say that during my time in the U.S. administration and when subjects related to this came up, I never heard anybody say, yeah, let's go for U.S. imperialism: That this would have foreign policy benefits. But I'm sure there are political science types out there that would talk about that.

And then the drawback is the one I said: The danger of implicit responsibilities and liabilities, such as thinking that the Fed has to take Argentina into account or other countries into account when setting monetary policy, even without the official sanction of a treaty.

But I think the benefits probably out-weigh the costs from our viewpoint, as well, and part of the reason is that the United States already bears some responsibility for leadership when international financial crises occur as they have over the last few years.

And that the probability of crisis in a country like Argentina would presumably be reduced under a dollarization plan. So, I would say that the idea merits American blessings even if it can't be official blessings.

Thank you.

MR. CHAIRMAN: Thank you, Jeff.

Let me turn to our second speaker today. That is Guillermo Ortiz, who is probably well-known to most of you. He is, of course, the Governor of the Banco de Mexico, a position he has held since January 1998; and prior to that he was Secretary of Finance and Public Credit for about three years; and he has had a distinguished career both in the service of the Mexican Federal Government and in a number of academic positions, both in Mexico and in the United States; and he was Executive Director at the International Monetary Fund during a particularly interesting period in the middle of the 1980s, Guillermo.

MR. ORTIZ: Thank you very much.

Well, I would like to, first, thank the IMF for inviting me to participate in this forum, and also to Miguel Kiguel and the Argentines for bringing the subject to the table so that everybody can have fun talking about it, as Jeffrey said.

Let me say, first, that, of course, the crisis in Mexico in 1994-1995 and then the Asian crisis and the Russian and the Brazilian problems of 1997-1999, they all had in common one feature which is that all these countries abandoned at one point their pre-determined exchange rate regimes. This is why, as Jeffrey has mentioned, both in academic circles and also in sort of official thinking, really there has been a more or less polarized view that, you know, what really functions is floating or having a real commitment to a fix, such as a currency board, or the adoption of another currency.

In Latin America, this polarization has been clearly illustrated by the different paths that on the one hand Argentina has taken since 1991, when they adopted their convertibility regime, also in the middle of a very deep financial and inflationary crisis, and the ones that Mexico and Brazil have taken later, also in the midst of a deep crisis. It seems like all these policy regimes are changed in the middle of very difficult times.

Mexico's experience with the floating exchange rate regime is already 4.5 years old. So, maybe a good starting point is to talk a bit about Mexico's experience with a floating exchange rate regime which is very relevant, of course, to the whole topic of fixed versus floating, and then make some comments about dollarization.

Let me tell you that when we adopted the exchange rate regime in 1994, and I was at the Ministry of Finance at the time, I thought that this was going to be strictly a temporary regime. We adopted it because we had no choice--we had run out of reserves and there was no way that we could have done anything else.

And given the fact that we had really no prior experience either in Mexico or in other emerging markets about the viability of the floating exchange rate regime, my thought at the time is that we would build sufficient international reserves. We would switch to a more predictable type of exchange rate regime. Because my fears were that the regime would be extremely unstable. We all learn in the literature that to have a viable floating rate regime you needed kind of deep markets and deep futures markets and forward markets and so, which were nonexistent in Mexico at the time.

However, if we look at what has happened over the past four-and-a-half years, we see, first, that the floating exchange rate regime has not been an impediment to a very significant lowering of inflation. Inflation has come down from over 50 percent, 52 percent in 1995, which is the year after we adopted the regime, to what we expect this year to achieve which is 13 percent inflation. And this is very much on target today, this inflationary target.

Second, this has also allowed the economy, I would say, together, of course, with complementary policies, a very substantial economic recovery. Mexico, over the past four years, on average, including 1995, is growing at an average rate of 5 percent despite the very severe crisis of last year, when the economy also grew 5 percent.

So, the floating exchange rate regime proved not to be sort of an inflationary-prone arrangement.

Second, volatility. We were very, very afraid that the volatility of the peso and dollar exchange rate would be very extremely high and it has not proven to be the case. Surprisingly, if you take the period 1996 to 1999, the last three years, the volatility of the peso/dollar exchange rate has not been, on average, higher than that of the dollar/yen or the dollar/deutsche mark exchange rate.

Of course, the development of forward and futures markets in pesos since 1995 helped a lot. You know, Mexico has sort of encouraged the development of the Chicago Merc trading in pesos once again and also of local futures markets.

Volatility of interest rates has not been also higher during this floating exchange rate period than during previous dis-inflationary episodes with more or less a predictable exchange rate. So, volatility has not been a big issue here. Volatility has not discouraged investments. In fact, if you look at foreign investment flows in Mexico they have held pretty steady in the $10-$12 billion range since 1993, 1994, despite the 1995 crisis and despite the Asian, Russian, Brazilian crisis.

Another very important feature is that the flexible exchange rate has allowed Mexico to weather the external shocks, I think, in a very satisfactory fashion. And it is interesting to compare, for example, what happened with countries with floating exchange rate regimes last year such as Canada, Australia, New Zealand and Mexico, all these countries were hit by terms of trade effects. In the case of Mexico it was oil; in the case of Canada, Australia, and New Zealand, it was other commodity prices that fell. And, of course, the adjustment of the real exchange rate that have to take place, given those external shocks, did take place in all these countries.

In fact, the real exchange rate depreciated in the four countries that I mentioned between 8 and 12 percent. And two things are interesting. One, is that growth was pretty much preserved except for the case of New Zealand; but Australia, Canada and Mexico growth was preserved last year and growth in these countries is also proceeding at a pretty healthy pace this year.

While in contrast, both Hong Kong and Argentina, that had these sort of convertibility of the currency board regime, they both have suffered recessions. Of course, as Miguel pointed out to me at lunch, the fact that we are next to the U.S. and the fact that Argentina is next to Brazil may have something to do with it, no?

[Laughter.]

MR. ORTIZ: But nonetheless, there is another example. If we look, for example, at the so-called Tequila effect, what happened in 1995. In 1995, Argentina went from growth of plus-8 to minus-4. That is in 1994, 1995. Mexico from plus-4 to minus-6, but the correction of the current account deficit in Mexico was almost 8 percent of GDP, while in Argentina it was only 2 percent. So, for every point of correction of the current account deficit the effect on GDP growth was three times greater in Argentina than in Mexico.

Now, what is the flip side? The flip side, of course, is that last year, you know, when the Asian crisis hit and the currency had to adjust, of course, inflation was higher in Mexico. Of course, inflation, the pass-through of exchange rate to inflation was much higher in Mexico than in Canada, Australia or New Zealand.

And this has to do a lot with history, with credibility of monetary policies, and this is one of the big challenges that we are facing today in Mexico in the conduct of monetary policy. And we have to really build sufficient credibility so that this pass-through from exchange rate movements to inflation ceases to be such an automatic reaction. And I think we are getting a little headway now because what preliminary information that we have is that this pass-through effect has actually come down a bit over time.

So, all in all, I think that Mexico's experience has been very satisfactory against my own initial judgment, I must confess. That is why I am a most recent convert to flexibility.

Let me talk a bit about dollarization. I think Jeff, frankly, has already gone through a taxonomy of cost and benefits of dollarization as it is particularly applied to Latin America. But let me just say a couple of words about it.

When we think about dollarization for Latin America there are basically two considerations that one has to look at. The first is the kind of benefits that a country would accrue by the adoption of another country's currency. And there you have, of course, the literature of optimal currency areas. At least a series that were already mentioned of the kind of conditions that should be met for sort of countries to adopt a common currency. And if you look at these conditions, of course, practically none of them are met by Latin America in terms of their relation with the U.S. except for capital mobility. There is really no labor mobility, there is not a lot of flexibility in the real economy side.

So, the only question to look at is, of course, how integrated are Latin American economies with the U.S.? And, yesterday or the day before I asked somebody at the Bank of Mexico to run a few correlations and it was very interesting. The correlations have to do with growth rates in Latin America and in the U.S. for the period 1970-1998 and then we run some correlations between the Euro-11 countries and then between different regions of the U.S.

And, of course, the correlation of growth rates between Latin America and the U.S. is very low. It is 0.5. The correlation among the Euro-11 countries is .38. And the correlation among the major regions of the U.S.--we divided the U.S. in like 6 or 7 regions--is much higher, it is .60.

So, obviously, there is nothing in the kind of literature of currency areas that would suggest any benefits of this kind of adoption of the common currency, the dollar, for Latin America.

So, the other aspect then--I think Jeff already touched on this--is basically the issue of credibility by the adoption of the dollar. And I think that the way it was put is the way I also thought about it. Is that the adoption of the dollar is really a statement about the political decision that could guarantee, you know, better macroeconomic policies because the cost of reversal is extremely high. It is like when Cortez got to Veracruz, you know, and he disembarked in Veracruz and his soldiers started getting a bit nervous because they saw what they were facing, he had the ships burned, no?

So, this is the kind of analogy that I think is pretty much appropriate for thinking about dollarization.

[Laughter.]

MR. ORTIZ: I think on the benefit side, of course, it is reduction in interest rates, reduction in inflation. There are two additional benefits which were not mentioned that I think are important. And one of them is a big incentive to fiscal discipline and financial discipline. Of course, upon adoption of the common currency the margins of maneuver on the fiscal side will be very much reduced. So, again, this is part of the policy statement.

And on the financial side, the fact that there is no lender of last resort in the system, of course, requires a very strong financial system that has to have ample liquidity and credit lines from abroad to substitute for this lender of last resort. So, I think these are two advantages that are being mentioned.

Among the disadvantages, of course, is that while you are giving up, I think, an instrument--not so much an independent monetary policies, this is important--but I think you are giving an additional cushion, an instrument to absorb external shocks. I think this is the basic point. I think that we have no illusions that we can run sort of an independent monetary policy but I think the flexibility of exchange rate has proven in the case of Mexico a very effective way of dealing with these kind of external shocks and preserving economic growth.

Well, of course, among the disadvantages, there are two or three other points that perhaps ought to be made. One, of course, is that the possibility of a run on the financial sector can be amplified if there is no lender of last resort. I mean there are two sides to the argument. On the one hand, the benefit is that you require a very strong financial system. But the flip side is that when it is tested then you know whether it is really strong enough or not and this is a potential source of vulnerability.

And lastly on these comments on dollarization, I think that it is clear that currency risk will probably be almost eliminated. I say almost eliminated because there is always the possibility of reversal so, it's not 100 percent. But country risk, I'm not so sure. Why is that?

There are two things. One of them is the possibility, of course, if you dollarize and you burn your ships, that means that you cannot really liquify the domestic debt by the usual Latin American means of inflating. So, that puts an additional burden on the country. So, you know, it depends on the size of the debt. It is a potential addition to country risk.

The second is that if you convert a sizable part of the domestic debt into dollars, that might actually raise spreads rather than lower them. Because you are putting--you know if Brazil, that has a very substantial amount of domestic debt in reals, all of a sudden is put into dollars, who knows what will happen to the dollar-denominated sovereign Brazilian debt. I mean the effects are not clear.

To conclude, let me say that at least in the case of Mexico, I think for Mexico what makes sense is the following. We are, as you know, members of NAFTA, and the process of integration of Mexico into North America has taken decades but it has obviously accelerated since the adoption of NAFTA.

So, we are at the juncture now where our NAFTA partners, you know, the U.S. and Canada, they have very desirable characteristics. Namely, for the first time in decades, both the U.S. and Canada, have fiscal surpluses; both the U.S. and Canada have very low inflation; and both the U.S. and Canada have very strong financial systems.

So, to the extent that Mexico converges to these benchmarks, to these characteristics of these two economies, the question of the appropriate exchange rate regime becomes much less important, as Canada has found out. I mean Canada has been floating for 40 years and they have done well. I think that, you know, for us again this quest for convergence really solves the problem because any exchange rate regime will function better the closer we get to these three characteristics.

Thank you.

MR. CHAIRMAN: Thank you.

So, let me turn to our third speaker, Dr. Miguel Kiguel, who is Under Secretary of Finance and Chief of the Cabinet of Advisors in Argentina. Prior to his current position, he was Deputy General Manager for Economics and Finance of the Central Bank of Argentina. He has also served as Principal Economist in the Chief Economist's Office at the World Bank and has held a number of academic positions both here in the U.S. and in Argentina.

I will not ask him to comment on the idea of putting Eva Peron on the dollar bill, but, thank you, Miguel.

MR. KIGUEL: Thank you.

First, I want to thank the IMF for inviting me here. I think it is a great honor to be accompanied by such distinguished panelists. And exchange rates has been a topic that is extremely interesting and, clearly, of great attention at the moment in Argentina.

Now, Jeff started his talk by saying that the U.S. was surprised by what at the time was actually President Menem announced dollarization. I must add that at the time we, at the Ministry of Finance and the people at the Central Bank, were also surprised by his announcement.

[Laughter.]

MR. KIGUEL: It is not that we are not prepared because that is an idea that we have been discussing, but the timing completely caught us off-guard and the Central Bank had go to quick and prepare the blueprint for dollarization.

Having said that, let me start by saying that I think that Argentina is somewhat special. I basically can fully understand Guillermo's position about the success of the floating rate in Mexico and, in fact, people in Brazil are very happy with the floating rate at the moment. People in Canada have been having the floating rate for many years.

But in our case, the fixed exchange rate, the convertibility law of the Currency Board that Argentina has had since 1991, we perceive it as a great success. So, we are starting from something that has worked and has been very effective in Argentina. The Currency Board, the fixed exchange rate that has allowed Argentina to have probably the best performance in the century, given that it is a little late in the century, but clearly one of the best performances of the century with a growth rate exceeding 5 percent per year, in spite of having a recession in 1995 and another one now.

With inflation stopping being an issue, no one talks about inflation, no one knows when the number comes out and it is not as important a number as it is in the U.S. right now, and investment has been at the highest levels we have ever seen and never attracting so much foreign direct investment probably since the 1920s in Argentina. So, almost in every way that you look, the system has worked. The second thing which is important to understand when you look at Argentina is that Argentina is today a very highly dollarized economy. For instance, you go and you can pay the taxicab in dollars. People think in dollars. Whenever one mentions a big figure, it's a dollar figure. The peso exists as one-to-one, but people in general think in terms of dollars. And the capital market functions fully in dollars.

For instance, Argentina's debt, the public debt, 92 percent of Argentina's public debt is in dollars or foreign currency and only 8 percent is in pesos. If you go to the banking system, 58 percent of deposits in the banking system are in dollars. That is up from 46 percent in 1994.

If you look at time deposits which represent savings of Argentines, 74 percent of time deposits are in dollars. So, the peso continues to be work primarily for transaction purposes but Argentines have made a decision that they want to save or we want to save in dollars by and large.

And even on the credit side if you look at numbers on bank credit, 66 percent of bank loans are at the moment in dollars. So, the first thing is that perhaps we are different. I mean we are not talking about a country like Mexico, like Brazil, like Canada. We are talking about a country which its history, which a Currency Board which has been successful and which an economy that is highly dollarized, which a big part functions in dollars.

Now, why does one think in an economy that has been so successful, that is growing so fast about dollarization? Why is it even an issue? Because in spite of the success that we have seen, that at a time of crisis, say, following the Mexican devaluation in 1994, following the devaluations in Asia, particularly after Indonesia, Korea and Thailand, after the Russian default, after Brazilian's devaluation, each time you get that the spread of peso/dollar goes up. In other words, the peso interest rates increase much more than dollar interest rates in Argentina and there is a premium on holding pesos, a currency premium and as a result of that one thinks why a country that is so strong do we have to go through these cycles and suffer so much each time that there is an external crisis?

So, that's a little bit the starting point. And in spite of being so successful, in spite of being, I think some people especially in Argentina are great believers in convertibility. If you talk to, for instance, any of the major candidates for President, they would say that convertibility is a great regime and, in fact, it has been but other people, some foreign investors, some foreign corporations in Argentina, that they believe but when there is a crisis they believe probably less.

So, that is the rationale and then let's to go some of the things that we have been discussing here. One is that Argentina, if it moves to dollarization, it would not have monetary policy. It would not have the option of doing monetary policy. That is one of the disadvantages that people say about dollarization, you can't run monetary policy.

In fact, Argentina is not running the monetary policy today. Argentina, since it already has a Currency Board, we do not have monetary policy. Money supply is essentially determined by how much money the people want to hold. The Central Bank does not target interest rates, does not target the monetary base, does not target any monetary aggregate.

Essentially we have what is called a passive monetary policy and the quantity of money is determined entirely endogenously in the system. The interest rate is fully market determined with no market intervention by the Central Bank. And from that respect we do not have a monetary policy today, so, why will you care about having a monetary policy in the future?

In fact, when we had monetary policy we messed it up. So, Argentines value the ability not to have monetary policy at the moment.

[Laughter.]

MR. KIGUEL: Now, that does not mean that the Central Bank does not do anything, okay? The Central Bank is active in some ways. And, in fact, it was active during the Tequila. How? Because the Central Bank still controls what were at the time reserve requirements, today I call liquidity requirements, and you know, that by changing reserve requirements you can affect the amount of credit in the economy.

And during the Tequila, when deposits were flowing out, the Central Bank reduced reserve requirements so that the credit in the economy did not suffer as much. It also has another instrument. It has a discount window for banks, which, within some limits, the Central Bank can lend in its excess reserves because there is a comparability law which says that for every peso that the Central Bank issues there has to be a dollar. So, the Central Bank can only give rediscounts if it has dollars backing that extra amount of money. But we did that. And we did also through some repurchase agreements in the banking system.

So, that is something that--the ability not to do monetary policy but to provide liquidity to the system in case of crisis is something that is important and I think it is probably the key issue today, probably the most important issue that separates Argentina from the [?], making sure that there is a system that ensures the Central Bank in the case of crisis can provide liquidity to the banking system.

Now, what are the advantages that we see in terms of dollarization? I think the biggest advantage would be a reduction in country risk. Now, Guillermo was rightly pointing to some--I mean almost right pointing that--

[Laughter.]

MR. KIGUEL: No, I am serious. He was making a good point that really devaluation or exchange rate changes and the ability to pay or default are not linked together. They are independent things that you can dollarize and you are going to have the same credit worthiness as before.

But, in fact, we believe, at least our experience from Argentina is that each time that there are devaluation fears, the country risk also increases. So, they are not fully independent events. If you can remove that devaluation fear, your country risk will somewhat come down. At least that is in Argentina. Again, I am not saying that that is true for every country in the world, I am very much speaking on data on Argentina and analysis we have done on Argentina, which is something that we understand.

And why is that? Let's say you take the episode of Russia after Russia's default. After the Russian default everyone became kind of crazy about the possibility of devaluations somewhere else. And Argentina, one of the things we've done and I think what has been the right policy, is that we accept globalization fully. We accepted lots of foreign compact, became part of globalized world and have lots of multinationals operating in Argentina.

And multinationals, sometimes you have to have a manager, somewhere in the middle of the Midwest or in the middle of Europe, who does not understand the difference between Argentina, Brazil, Mexico, Australia, New Zealand and they decide we are going to cover foreign exchange rates everywhere. And then someone, the Treasurer from Argentina calls the Treasurers in the headquarters and says, it does not make any sense. Argentina is not going to devalue. They say, I don't care. You cover your foreign exchange rates and that is it.

And, in fact, that has been happening a lot of times and that is implying costs because when the peso market is very thin in Argentina and when the firms want to cover and usually they want to cover large amounts, they generate a premium or increasing interest in peso interest rates, which are really not based on fundamentals but on some policy determined somewhere in the world.

So, that has been clearly one of the factors and you can see how this can spread through the economy and generate inefficiencies.

So, our view is that in the case of Argentina, at least, if the country dollarizes and removes the risk or finds some way of removing this risk altogether, which I think probably dollarizing is the easiest way, you would get reduction of somewhere between 150 and 200 basis points in the country risk, which is, I would say, a significant reduction in interest rates.

Another thing that perhaps makes Argentina different is that Argentina really has the reserves. I mean Argentina has enough reserves to dollarize tomorrow if it wants. It does not need to borrow, it does not need to do anything. Basically if the Government said to dollarize tomorrow, we can dollarize tomorrow. But does it make sense to dollarize tomorrow? I would say, no. I think the biggest benefits for Argentina would come from, not from a unilateral dollarization but really from a dollarization in which, a negotiated dollarization with the U.S. Government. And there, I think, there are two things that need to be negotiated which are important.

The first is this technical issue of seignorage. Seignorage, the way we think of seignorage in Argentina is essentially the interest payment, the interest that Argentina gets on its international reserves, the international reserves that back the currency.

We, at the moment, have roughly the equivalent of $15 billion in Argentine pesos. For this 15 billion pesos there are $15 billion. Those $15 billion are invested in U.S. Treasury Bills and that generates Argentina roughly between 700 and 750 million per year. That is roughly 2 percent of Government revenues. So, for Argentina, given the difficulties that we have in raising revenues, that is a significant amount, I would say.

That is one issue that we need to solve. I think there are ways. In fact, if Argentina were to change those Treasury Bills for dollar bills the U.S. would gain the $750 million that it is now paying to Argentina. So, in a way, I think that one needs to find ways, if possible, to see whether Argentina can benefit or can continue to earn the same interest it is earning today.

We are not asking for more. It is basically trying to earn the same money that Argentina is earning today on having U.S. Treasury Bills.

The second issue, perhaps, is probably more important--I am not sure whether it is more difficult or less difficult than the previous one--is the issue of lender of last resort. As I said, that has been very important in the Tequila. That is something that we learned following that we had our own banking crisis, our deposits fell $7 billion, and, at the time we found ways of providing liquidity to the banking system.

Since then we introduced a number of things, a number of policies to increase liquidity in the banking system. But, obviously, if we dollarized our reserves will fall by $15 billion, immediately. We will go from $31 billion to $16 billion.

And I think that Argentina would need some way, some facility which does not need to be with the Fed, it can be something negotiated with a private sector, with a combination of private sector and multinational, multilaterals, maybe the U.S. Government--I think that that is where we need to think, I think we are very open to ideas--to provide the Central Bank with the ability to act as a lender of last resort.

Our experience has been that once you have enough liquidity, as we have now, probably you will never have to use it. Our experience is that after the Tequila we generated enough liquidity in this system and we expected a number of crises that never happened. I mean the financial system has been very strong. There were no runs on deposits. We did not see a repetition of the previous crisis.

Clearly, preventive policies work, but you need to have the insurance, you have to have those policies in place in order to make sure that the event doesn't happen.

So, basically I think if we can solve this issues of seignorage, we can find a way of strengthening the lender of last resort, then Argentina probably can get dollarization. And as I said before, I think unilateral dollarization does not get rid of the problem, especially of lender of last resort, so, it would not be a solution for Argentina.

To wrap up, I think that we do not expect dollarization to be a panacea. I think it is clearly no magical solution, it is not a solution to all problems. Those who think that way are completely wrong.

I think Argentina, in the case of Argentina, dollarization is a way of deepening or strengthening our existing currency regime, strengthening convertibility. Strengthening convertibility so that it can do more, can help more Argentines in having less volatility in interest rates, give more predictability, in terms of exchange rate policy, if you want, or removing uncertainty for the future. And we believe that it is probably convertibility or dollarization that is the right regime for the world where there has been a lot of financial turmoil, and Argentina has been able to survive a lot of shocks. We suffered the Tequila, but the ones that came later to Argentina, especially the financial sector, managed to overcome them, particularly well.

Of course, either with convertibility or with dollarization, Argentina will need to continue to have very strict fiscal policy. We will need to continue to have a very sound debt management and we will need to continue to strengthen even more its policies for the banking sector, ensuring that the banks are solvent, and that they are liquid.

But if we can do that, I think that it would be a good step forward.

Thank you.

MR. CHAIRMAN: Thank you, Miguel.

Let me turn to our last speaker, Eduardo Borensztein, who is the Chief of the Developing Countries Studies Division, here, in IMF's Research Department. And he has spent some time recently thinking about these issues.

So, Eduardo, let me turn it over to you.

MR. BORENSZTEIN: Thank you.

Well, all speakers have been banned from using transparencies or other media but being an insider has some advantages so I got a dispensation to show one transparency, which I think it is going to show that despite what we heard from Miguel Kiguel, I think the plans for dollarization are coming down just to the final details at this point.

[Laughter.]

MR. BORENSZTEIN: This is a design of the new $100 bill.

[Laughter.]

MR. BORENSZTEIN: The front is familiar but in the back you see the map of the Western Hemisphere, and if you can read that it says, cien Estados Unidos America.

It is written in Portuguese, below that, showing--

[Laughter.]

MR. BORENSTEIN: --showing some foresight.

I think in studying the proposal for dollarization, we face two kinds of problems. First of all, we don't have any experiences to draw from. There are very few countries that have adopted the dollar or foreign currency and basically beyond small island economies you only have the case of Panama that, itself, is a small economy with a very strong link to the United States to begin with, so, it can give only limited lessons.

And the other aspect is that you have to think of dollarization as a proposal that is hard to reverse once you adopt it. It is almost a permanent change. And you have to think not just would this be the right policy for the next 2 years or 5 or 10 years, but would it be a step you won't regret even if the more extreme circumstances will come to pass.

And I think because of these difficulties, what we end up doing, and I think the speakers here did as much as other analysts, is making a list of what are the pros and cons, making a list of the issues that may be problems or that may be favorable but not really coming down on how to compare them or how to quantify each one of them.

It is clear, of course, that dollarization would not mean the same kind of step for say Mexico or Argentina, to pick two countries, as an example. Mexico has a floating rate and dollarization is the ultimate fixed rate. But, on the other hand, Mexico has a very close trade relation with the United States which Argentina does not.

But, yet, Argentina has, first of all, a Currency Board arrangement that already comes very close to using the U.S. dollar and it has a substantial, as Miguel mentioned, amount of dollarization already driven by the market in terms of bank deposits and loans, in terms of dollar currency in circulation or contracts and contracts.

So, it's clearly a much smaller step for Argentina. For Mexico, it would be both to move from a floating rate to a fixed rate and a very hard fixed and, of course, adopting another currency not just a fixed rate.

So, what is the list? Let me briefly summarize the list of issues that have to be considered and, I think, to a large extent have been mentioned already.

It is clear that we are not thinking very much at this point on the traditional optimal currency area literature, we are thinking really on gaining credibility and gaining some isolation, some protection from contagion and factors affecting international capital flows. Although, of course, the optimal currency arguments are somewhat in the background of the discussion.

So, what are these issues? Well, some of them are relatively easier to have some measure or some assessment of. First, the seignorage issue. Well, we know countries will lose seignorage and we can roughly quantify that. Second, the issue of avoiding currency crisis or lowering the country risk premium, that was mentioned. Of course, if the U.S. monetary policy continues to perform the way it has performed, it is unlikely that there will be a run on the U.S. dollar and by adopting the dollar, the country can be free from currency crisis. That would help to some extent to reduce the country risk or the sovereign risk that is reflected in the spread of the dollar denominated debt of the country.

Now, how much of that spread really depends on the currency risk? How much of the spread on dollars denominated Argentinean debt, for example, is related to the probability of a devaluation of the peso or an abandonment of the Currency Board in the midst of a crisis? That becomes a harder question.

It is clear that there is a very close correlation, as Miguel noted, between the two, between the currency risk and the sovereign risk. It is a little bit harder to establish that the causality goes from currency to sovereign risk and not for maybe a third factor that affects both.

And here you can look at, for example, Panamanian foreign debt, dollar denominated debt, and you do see at this point lower spreads, significantly lower spread on Panamanian bonds than, say, Argentinean bonds. But Panamanian bonds are not fully protected from contagion or from international market sentiment. The volatility of this spread follows very much the movements in other emerging markets. Panama is still affected, its sovereign risk is still affected by international financial markets for emerging markets.

Third, there is the issue of lender of last resort. How to provide the function of lender of last resort once you have dollarized? Again, this would be different in the case of Argentina which already has some limits to do it because of the rules that they have to follow under the Currency Board system than for a country that is floating like Mexico.

Yet, one has to take into consideration that even if you are floating, even if the Central Bank has the ability to print money to support financial institutions, that, in fact, there are limits. If you have a large problem in the banking sector, I don't think you can get out of it by printing money because pretty soon your exchange rate is going to collapse and you're not going to be in a situation that you can solve just by keeping the ability to print money. But it is true that you do have more flexibility in that case.

Now, there are other issues that are perhaps harder to have an assessment. For example, what is the value of having monetary independence? Miguel mentioned, well, we think it wouldn't have value. We don't have it now, and we wouldn't have any use for it. Whereas, Guillermo thinks they have been using it pretty well in the last 4 or 5 years. And I think these different histories of the two countries and, of course, the different current regimes exemplify that. But I think that it is true that the more open economies become and the higher the level of capital mobility, the less the margin there is to do monetary policy as Jeff was also mentioning in the beginning.

There is also the issue of compatibility with regional trade arrangements or different regional trade patterns that countries may have? And I think there are interesting cases here to compare. Argentina, of course, is involved in MERCOSUR where there are questions of whether there is a consistency between Argentina now having a hard peg and moreover adopting the U.S. dollar whereas other countries, in particular, Brazil, the largest one, have a floating rate, and whether the instability on the bilateral exchange rate that may follow would be consistent with maintaining the regional arrangement.

In the first place, I think, dollarization would not make the situation worse. I think currently you already have one country with a firm peg and the other one, the large partner, having a floating rate, and that could produce large misalignments. I guess it depends on the circumstances. If one looks at the recent history there have been very wide fluctuations in the bilateral rate between Argentina and Brazil but these were mostly related to periods of very high inflation and the stabilization that followed and more recently by the currency crisis in Brazil. Outside of those periods of high monetary instability you didn't see a lot of exchange rate volatility.

What about Mexico and the U.S. through the NAFTA agreement? Again, the bilateral rate does have some volatility but it hasn't been such that created a serious political problem so far at least. But one could think that if this agreement were to broaden--and looking at the experience in Europe, for example, with the European Union becoming a single market--that is not just lifting barriers to trade, not just tariffs and barriers on the border, but having more uniform regulations and laws so that the markets become effectively a unique market. I think at that point exchange rate fluctuations become much more problematic. So, I do think that the existence of this regional arrangement to the extent that it deepens towards creating a single market could be a factor towards a common currency.

Of course, the same thing would be true in Mercosur, and then you would have to worry if all countries in the region may be willing to adopt the dollar.

And then to finalize. I think one of the potentially biggest benefits from dollarization is one that would be the hardest to make an assessment about. The issue is by gaining the stability of adopting the U.S. dollar, by increasing integration with the United States and with the global economy, would these promote an increase in international trade, an increase in foreign direct investment, a gain in credibility in the institutions? That could essentially accelerate the convergence of, say, Argentina or Mexico to the United States' economy significantly.

And, here, again, it is a point that given the few country experiences and few examples to draw from, I don't think we can say much, potentially this is a huge benefit, but I don't think we are in a position to make a firm assessment.

Thank you.

MR. CHAIRMAN: Thank you, Eduardo.

Okay. So, it's time for some questions now.

Perhaps if I could ask those who would like to ask questions to briefly identify themselves and if the question is directed to a particular one of our speakers they could say that.

And if I could just also make a plea to make them short questions and not speeches, okay?

Thank you.

QUESTION: This is for Mr. Kiguel. At this stage, where do the negotiations with Argentina stand?

MR. KIGUEL: At the moment there are no negotiations. What we are, I think that we had a number of talks with the Treasury and the Fed. There has been a lot of interaction in terms of discussion of the idea, but that so far is essentially what has been happening. We, at the moment, I think at least on the side of the Argentine Government, what we would like at this stage is to see whether we can get a working group to discuss some of the technical issues that I mentioned here, such as seignorage, implications for or the possibility of finding a way so that Argentina can have a lender of last resort. But I think that until we get--before we need to understand exactly what the technical issues are, try to solve them, and if at the technical level we can see that there are options, viable options, then I think we would start negotiations.

But we don't see any point at this stage, we don't see any usefulness in starting negotiations.

MR. CHAIRMAN: Okay. Perhaps let's take 2 or 3 questions at the same time.

MR. MILLIGAN: James Milligan, J.P. Morgan Investment. I have this question for Mr. Kiguel. What are, domestically within Argentina, what are the procedures within the legal framework that have to be undertaken for convertibility to proceed?

MR. KIGUEL: At the moment we have the convertibility law, which is obviously a law, and it can only be changed by another law. So, obviously, if we were to go ahead we need the approval from Congress. But at the practical level, I would say that you probably know that we are in the process of an election period, and elections are going to take place October 24th. The new government will be in place December 10th. And, so, at this stage, I think that the best one can expect is really to start the technical discussions and really a decision how to continue I think will be best to be decided by the next government.

But in terms of just procedures, I think it is just the executive sending up to Congress and Congress approving maybe authorization to negotiate with the U.S.

QUESTION: [?] of Lang, Millen and Bond. I have a question for Mr. Ortiz. If it is--I would like him to maybe comment on the point that as laws and regulations between the United States and NAFTA harmonize more and more, the point was made by Mr. Borensztein that the logic or the pressure toward or the attractiveness of dollarization increases because the influence of and exchange rate movements between the peso and the dollar become more of a shock to the market. Do you agree with that or if not, could you comment on it?

MR. ORTIZ: Well, as I mentioned, first perhaps a couple of numbers. NAFTA has been in terms of the increase in trade in North America a spectacular success, much more than anyone thought at the time when NAFTA was implemented at the end of 1993. You know, trade between Mexico and the U.S. has almost doubled over the past 4 or 5 years. Trade between Canada and Mexico has increased even farther, although we started, of course, from a much lower base with Canada.

So, the trend of Mexico has become already in the number two trading partner of the U.S. displacing Japan. So, the fact that we have had a floating exchange rate regime and a very volatile one particularly in 1995, was not a deterrent to international trade, has not been a deterrent for investment, either.

Investment flows have grown--they have trebled, you know, from their pre-NAFTA levels. You take an average of say 1991 to 1993, and average 1994 and 1999, and that foreign investment has trebled. And, so, this has not been a deterrent.

On Canada's side, well, Canada has been floating for many, many years and I think that they are very happy with their exchange rate arrangement, you know? So, it doesn't necessarily divide, let's say from that trade relation that we move to a sort of monetary arrangement. Although it certainly from their sort of optimal currency area literature it makes a lot more sense for the region. But I think that even politically I don't see it, let's say, in the immediate future.

Just one more point. Even I think a modest agreement with Argentina of the type that has been discussed I think would be a huge political step in this country.

QUESTION: Japan Economic Institute. I just wanted to ask regarding if there was any domestic political resistance to losing a symbol of national sovereignty, the currency, in Argentina, and how the general populace would perceive it?

MR. KIGUEL: That is difficult to say because we would, really there hasn't been any negative response so far. But really I mean I haven't seen any negative sentiment but it is difficult to judge when the time comes how it will go.

QUESTION: Graham Stock [?] from Chase Manhattan Bank. I have got a question for Mr. Kiegel. As you said in times of financial stress we have seen an increase in peso/dollar spreads, and a move out of peso deposits into dollar deposits. Could we see a de facto dollarization of the Argentine economy without any government action just by dint of all deposits being converted into dollar deposits? As you said, 92 percent of public sector debt is already dollar denominated. And, so, could we see a de facto dollarization?

And the second question. Is it a given that in the case of the government implementing dollarization it has to occur at a one-to-one peg? Could the government buy back the pesos at a rate of 1-to-1.2, or 1-to-1.5 to try and overcome the loss of competitiveness that Argentina has seen in the last few years?

MR. KIGUEL: Regarding to the first question on the issue of de facto. What we have been observing is there are two different trends. One is what happens with transactions and the peso continues to function well in terms of satisfying every day transactions and wages continue to be paid in pesos. Taxes are being paid in pesos. So, the peso continues to function for transaction purposes. And, in fact, we haven't seen any reduction in that.

What we have seen is more and more dollarization in the capital market. So, people, the economy that is more or less, we seem to be converging to is one in which pesos are used for transaction purposes and for units of account for every day transactions. And dollars are used for the capital market transactions and big-ticket items, for instance, you know, you sell an apartment, the apartment is $200,000.

I don't know why. It appears even like that in the newspaper, that the peso and the dollar are exactly the same.

So, I really, that seems to be more or less the way the economy seems to be functioning and functions well in that respect. So, I don't see, I don't really expect much more dollarization than we have seen more going naturally, or de facto.

Regarding the second question. I just don't see any possibility of changing the one-to-one in any case. And I think that it is true that Argentina has seen a number of adverse external shocks that affect its competitiveness in the short run such as, you know, significant reduction in commodity prices, a recession in Brazil, the devaluation in Brazil, the super-strength of the dollar. So, all these things are clearly affecting to some extent Argentina, but Argentina has overcome these type of situations in the past and these usually come in cycles.

I mean so we are already starting to see a slight--clearly the economy has bottomed up. We don't see any more tendency for the GDP to decline and the latest numbers in industrial production on a seasonally adjusted basis of GDP start to show a modest growth, at least moving in the opposite direction as we have been moving in recent months. So, from that perspective, I am not particularly worried about the competitiveness.

I think that Argentina's productivity gains have been so large in the 1990s that we can still overcome a situation like this just over time.

MR. BORENSZTEIN: I just wanted to add a comment. If you actually buy back the money supply of the currency at say, 2-to-1, you would be reducing the amount of money by half. I think even the Fund would think that that is too tough a monetary policy.

[Laughter.]

QUESTION: On a question for Mr. Kiguel. If Argentina was adopting the dollar do you think it would change its strategy towards Mercosur? Would it make it closer to NAFTA and MERCOSUR or would it still stay in Mercosur?

MR. KIGUEL: No. Argentina has made a strategic decision to stay within Mercosur, to have MERCOSUR as a group and all the trade policies are going to be negotiated within MERCOSUR and MERCOSUR with other groups. That is clearly the position that this administration have and from what we know the future administrations are probably going to follow a very similar policy.

There has been raised an issue regarding whether the MERCOSUR can work with different currencies and, in fact, that is what we have now. We have the peso with one regime, we have the Uruguay/Paraguay different regime and one for Brazil with a floating rate. And now, and we learned from what Guillermo said that it is perfectly possible to live with different exchange regimes within a trade bloc.

How would it evolve is kind of an unknown and I think it is very early to tell. I think that given today's situation each of the countries in the region are finding the best equilibrium possible without threatening the [?] because we think that MERCOSUR is critical and will continue to be critical for Argentina in the future.

QUESTION: Dave McKensie, World Bank. This is a question for Mr. Borensztein. Mr. Kiguel suggested that if the Fed is not prepared to be a lender of last resort, perhaps multilaterals could provide a role here. What do you think the IMF's role is in a lender of last resort for Argentina?

MR. BORENSZTEIN: I think this is a question for Mr. Goldsbrough.

[Laughter.]

MR. GOLDSBOROUGH: The short answer is I don't think it has one.

[Laughter.]

QUESTION: We have been hearing a lot about Argentina and Mexico but the title of this forum is Fad or Future for Latin America. So, I would like to ask Jeff Frankel and Eduardo Borensztein, what other countries you think should be giving serious consideration to the possibility of dollarizing?

MR. FRANKEL: I think if you run down the list of characteristics that I said that some of the obvious candidates are in Central America and the Caribbean but particularly the traditional characteristics, the optimum currency area, small and open, these countries do trade a lot with the United States and there is some labor mobility, some movement of people back and forth which is one of the classical criteria. Mundell's original classical criteria for an optimum currency area.

Argentina, of course, is a bit surprising perhaps that the issue of dollarization has arisen in that context because it is a fairly large country and trade is not that large a share of GDP, although it's been increasing, and it is far removed from the United States. And there the character that qualifies it is this one of almost a desperate desire to import monetary stability due to the history of hyper-inflation that creates a wide popular support for it.

Elsewhere in Latin America, it is hard to say. I would think Brazil would probably be one of the least likely to qualify given its size and its ratio of trade to GDP which is one of the reasons why I think that the regional solution for MERCOSUR doesn't work.

MR. CHAIRMAN: I think we have got time for just one or two more questions.

QUESTION: I would like to ask about recently both President Menem and President Cardoso mentioned converging the economic policy much like the European Union did in its first stages to get to a common coin, to the euro. How would that--I mean if this is being done, how does this, how is it compatible with dollarization?

And also for all the other panelists, I would like to ask, since Menem's idea of dollarization came as a surprise, why is it that all of a sudden that everyone like the American Treasury, the American Congress, the IMF, the IBD, everyone is talking about dollarization every two days?

Thank you.

MR. : Okay.

I can handle the first one.

[Laughter.]

MR. KIGUEL : I think that the view of Maastricht type of agreement on convergence of macroeconomic indicators is something that has been long overdue for MERCOSUR because it's clear that macroeconomic instability is something that hurts trade rather than helps trade. And I think that what they have decided to try to start the working group to set macroeconomic targets for variables such as inflation, the budget deficit, interest rate, levels of debt makes a lot of sense. Now, that is a long process. In fact, negotiations have not even started and it is is unclear how long the process will it take. So, we really don't see the possibility of moving to dollarization as being incompatible with the MERCOSUR agreements because, you know, since this can go in stages, I think that it is feasible to go with these two approaches and eventually we will see how it moves.

But we don't see this as incompatible. I think they can work.

MR. FRANKEL: --the second half. The second half is to why this has produced such a big reaction? One point is Carlos Menem is in many ways a good politician. He didn't just pull us out of the blue, he sensed that there was some support for it. And clearly currency boards have produced a lot more support not just in Argentina but in a number of other countries than any of us, most of us would have predicted 10 years ago.

The fact is that people are disillusioned with the record of monetary policy in emerging markets and the record of speculators attacking currencies over the last 10 or 20 years. And there really is a hunger for something different. So, I think that that is part of the answer.

And also, why there were favorable reverberations elsewhere in South America and in Central America, El Salvador has been thinking about it, and the business community in Mexico has had some positive reactions.

As far as the United States goes, the new Treasury Secretary has some personal interest in this, I think; Larry Summers, I think finds it intriguing. And some in Congress are interested in this. I mean usually it's really tough to explain something like seignorage in Congress and that is why I am not real optimistic about the possibility of giving the Argentines back some of their seignorage. But it's possible because there are a surprising number of Congressmen and Senators who whether it's because they read the editorial page in the Wall Street Journal or for some reason are really intrigued by this whole notion of currency boards and dollarization.

QUESTION: My question for Mr. Ortiz is if the higher interest rates associated with a floating exchange rate do not have significant impact in growth and, if so, if the short-term advantages of floating exchange rates do not compensate the long-term impact in growth terms?

MR. ORTIZ: Well, I think that it's not inherent to floating exchange rate regime to have high interest rates. It is a reflection basically on the credibility of monetary policies under either, you know, fixed of floating exchange rate regimes and the notion of sustainability in the case of a fixed exchange rate regime.

I think that in our case there has been a substantial real interest rate premium that, of course, increased drastically last year after the Russian default because there was a qualitative change, I would say, in the world in terms of risk perception for emerging markets. But as I mentioned to you before if we compare periods of dis-inflation in Mexico when we had fixed rate versus floating rates actually volatility has been lower under the floating exchange rate regime than on the fixed exchange rate regime and the level has not been higher either.

Here, the question, I mean the basic question of why interest rates remain higher in Mexico, I think there are two. One, of course, is that Mexico is still in the class of emerging markets and the asset class of emerging markets and as it was mentioned U.S. interest rates have a first order impact on all these asset class.

And second is that we still have, you know, a lot of credibility, let's say, to work on in terms of our monetary policy. We are travelling on uncharted waters. You know, in every episode, at least in Mexico and I would say in most of Latin America, every dis-inflation effort almost has been exchange rate anchored. So, you have to, you know, change the anchor and turn it into a monetary policy anchor and that requires basically credibility, and there is just not the record for that.

MR. CHAIRMAN: I think that is all the time we have, given the schedules for the departure of some of our panel members. But I would like to thank them very much for a very stimulating discussion. [Applause]