The Inside Story of Dollarization in El Salvador — Manuel Hinds

Former Minister of Finance Manuel Hinds joins us for an eye-opening account of how El Salvador dollarized. We get down to the nitty-gritty of monetary policy and prudent governance in what should serve as a poignant lesson for the Caribbean region. 

Dollarization in Latin America is back in the economic headlights. The policy is simple. Encourage the use of US dollars as a unit of an account in a country other than the USA to aid the fiscal stabilization and long-term growth of that country, yet from all corners, you have professional economists slinging unjustified objections to dollarization.

Always in these cases, they never gave actual examples of countries that have dollarized. How did they do it? What happened on the ground? What were the empirical results? Instead, they retreat into abstract theorization. 

Through this discussion based on the world as it is, and not mere abstraction, it can be seen that dollarization is a simple, elegant, and powerful policy that any economy in Latin America and the Caribbean should adopt.

Transcript

Main Part:

Rasheed: Manuel, thank you so much for agreeing to have this conversation with me today in beautiful Barcelona. 

Manuel: Hello, Rasheed. It's my pleasure to meet you and have this nice conversation. 

Rasheed: So I'm very interested in finding out how you have come to approach dollarization as a potential policy for El Salvador.

At this time, back in 1995, 94 when you first introduced the idea to the government in El Salvador, no other country had moved forward with dollarizing. Ecuador did not dollarize at the time. It was still early days for such conversations in Argentina. Panama was the only one that was dollarized, but that was the case for a hundred years.

So how did you come to think that dollarization was a good idea for a policy in El Salvador?

Manuel: I had worked at the World Bank for a long time, and actually in the years before I went into the government in El Salvador, I was in several missions, World Bank missions, in Israel and Palestine. This was 1993, 1994, or something like that.

And this was the time, maybe you know, don't recall because you were very small probably at that time, that at this time there was this idea that progressed a lot of establishing a Palestine state, what they called the two countries solution. The idea was that the World Bank would help in advising how to Organize the new state because we thought that this was going to succeed and I was in charge of looking at the currency. And always the problem that you face when designing a currency is how you protect the public from the abuse of money, where the politicians start printing money and they are very happy, but this leads to inflation and all the problems that you can see in Argentina now. And then I thought a lot about the possibility of dollarizing Palestine. Because what you do when you dollarize, you cut the power of the politicians to abuse the possibility of printing money.

And then how do you do that if you don't know who is going to be the president? Maybe this president, if I know that you are going to be the president, you will be a prudent man. But what about the next one? You don't know. So I thought a lot about that, and then I thought that maybe in El Salvador, it could be interesting. But there is something I want to tell you, which is very important in the case of El Salvador.

In Ecuador and Argentina, the idea of dollarization came because there was a crisis. There is a crisis. Inflation is very high. In El Salvador, nothing of a sort. In El Salvador, we dollarized when our inflation was 2 percent per year and the economy was stable. Why did we dollarize? The problem that we were having in El Salvador was that we had a war, a civil war in the 1980s.

And then the new government came in, Cristiani, then Calderón Sol, and then Flores. And Cristiani faced 30 percent inflation. Which, compared to Argentina, is nothing, okay? But to El Salvador, it was a lot. And then, the economy was stabilized with a traditional solution. The traditional solution is not to print more money.

Period. Okay? And then, the country established something like the currency board in Argentina, but informally. El Salvador never said we were not going to establish a currency board. We are not going to print money on the authority of the central bank, but we knew that we would do that. And we didn't want to raise expectations.

We wanted it to be done nicely. 

Rasheed: And who made that decision? 

Manuel: That was a political decision of the government, including the central bank. And actually, it was announced. In the sense, that we want to stabilize the country, we don't want to print more money. So what we are going to do is we are going to print money only if you give us a dollar.

If you give me a dollar, I'll give you colones. But the government will never decide, let's print colones without receiving dollars. This is the principle on which the currency board works. Also, we passed a law forbidding the central bank from financing the government, period. The central bank could not finance the government or the banks, except in a crisis.

Rasheed: What year was this? 

Manuel: This was in 1991. And then inflation started going down. Steadily, it started going down. And then when I became the Minister of Finance, at the time I was an advisor to the Central Bank, not full-time. 

Rasheed: You were still at the World Bank or is this after the World Bank? 

Manuel: After World 

Bank. I came back from the World Bank at the end of 1992. Then I was an advisor to the Board of Directors of the Central Bank, but I just went to the meetings and wrote some things so it was not full-time. When I became the Minister of Finance, inflation was already very low, and the next year, the inflation was 2%. I came to the government in January 1995, and then by 1996, I think it was already 2%.

Rasheed: You joining the government, this was an invitation from Calderón or what was that process? 

Manuel: Yes, Cristiani had left and Calderón Sol was the president. That happened in 1994. And then I became the Minister of Finance in January 1995. There was somebody who was the Minister of Finance for six months and then I was.

But then, the problem we had was that the rate of interest was very high. If you wanted to borrow money for a house, you would get an interest rate of 24%. 

Rasheed: 24%?! 

Manuel: Yes, because this was the rate of interest that you had when inflation was 20-something percent. And then the rate of interest didn't go down, even if inflation went down.

Rasheed: At that time, what was the main reason for the reduction in inflation? 

Manuel: Yeah, the inflation went down because the government was not printing money. The central bank was not printing money. And also, the government substantially reduced its fiscal deficit because it could no longer go to the central bank and tell the central bank to give me money. That was impossible because it had been forbidden by law. 

Rasheed: Okay, so why didn't the commercial banks follow through to decrease the interest rates that they charge on credit?

Manuel: The thing is, it was not a problem of an oligopoly, because you could think this is an oligopoly. They all got together and they said, let's not lower the interest rates because the deposit rates were very high also.

They paid a lot off. And then the problem was it was that people, the depositors, didn't believe that the government would no longer devalue the currency or print money. They said, these guys who are in the government right now, are not going to print money, and they are not going to devalue the currency, but what about the next one? They kept asking for very high interest rates, let's say from 15 to 18 percent for deposits. 

Rasheed: The bankers. 

Manuel: No, these were the depositors. How did they force this? Well, if the interest rates that the bankers paid were too low, they took the money and purchased dollars, went to the United States, and deposited them in Miami, let's say, okay?

So the banks learned through experience that if they lowered the deposit rates, they would lose deposits. So they kept it higher and then the interest rates were extremely high. 

Rasheed: So it was not primarily a profit motive or something else? 

Manuel: The problem is that people believe that we are going to devalue the currency.

So, let's make it un-devaluable and the way to do that is to dollarize. So then I proposed that. But I proposed that within a lot of other measures, which included, the privatization of electricity, telephone, and telecommunications, and also the reduction of protection. Industry in El Salvador was protected with more than 100 percent tariffs.

There was no real competition. And truthfully, you were giving the Salvadorean companies the possibility of really having an oligopoly and selling things very expensive at very low quality. So, we reduced that to six, on average, from seeing one hundred and something to six, okay? So, it was a lot of things that we were doing, but not in the way in which this is happening in Argentina.

Because the country had gone out of the war. People were no longer trying to have conflicts. So we negotiated this with the opposition, we spent a lot of time negotiating with them, explaining why we wanted to do this, and so on. And then we were having a lot of problems trying to pass the reforms.

And then I had a meeting with the president, with Calderón Sol, and he said, "Let's drop at least one. We have too many things in the kitchen, okay?"

Rasheed: Which interest groups, if any, I'm sure there has to be some, were pushing back the most against the policy idea? 

Manuel: The ones that were pushing back a lot were the industrialists, because they were going to lose protection. And we explained the problem to them. El Salvador couldn't export industrial goods because they were too expensive.

They were very inefficient. But then the political situation was such that we had to drop one of these things so that we could concentrate on the other ones and pass the reforms and so we dropped dollarization. 

Rasheed: Why dollarization, not something else? 

Manuel: Because it was the measure of reform that people understood least.

We thought it would be easier to pursue these other things and then the next government could do this other thing. Because also politically they were saying we are going to lose sovereignty and we had this other argument saying, "You're calling sovereignty the ability for the Minister of Finance to have some drinks and then, devalue the currency."

Do you think that you are sovereign? People prefer the dollar because at the time already if you wanted to have a contract, this happens in Argentina, if you want to sign a contract to lease an apartment, then you have to do it in dollars. Everything was in dollars, but people say, no, no, no, our sovereignty.

Yeah. And they were just taking dollars. But then we say, let's do the other things, which are very fundamental. And then when I came into the ministry, we were the last of the last in the ranking of the risk evaluation. We had a very bad qualification by Moody's, we were very bad. And then we became investment grade.

One of the two investment grades in Latin America, the other one was Chile. So we had access to investment. Because we reduced the debt to GDP, the economy started growing a lot. Because of the elimination of protection, the industry started growing, which was counterintuitive for them. But the thing was, they started exporting.

And then, that was it. In the next government, inflation was low. We had been growing 6 percent per year. So the economy was very healthy, but still, it was difficult to invest because the rate of interest was too high. 

Rasheed: And just so we're clear, when you say invest, you mean for companies in El Salvador to get credit to do domestic investment.

Manuel: Exactly, because you could not go to New York and say that you wanted to borrow directly in dollars because your income, your revenue was in colones. And this is a very important point. Then, when we dollarized, we dollarized on that reason, and we explained this. And we went to the National Assembly, there was a debate, a one-month long debate on the thing, and it was approved.

Rasheed: Okay, so let's tap back a little bit. Right now, in this timeline, President Flores, Francisco Flores, is the president of El Salvador. Why is it that his administration found it more politically feasible to do the dollarization process even regarding the industrialists, the pushback from other parties compared to when Calderón Sol was in charge? What's the difference there? 

Manuel: Because of two reasons, I think. Number one, because people had more time to evaluate the idea. When you are presented with, the idea of reform, this is something I saw with Milei, he's going to have a problem because he wants to reform everything. And then if you are a citizen, and I tell you I'm going to reform pensions and protection, then you become overwhelmed.

But if you have already done the other reforms and you say, we are going to resolve one problem, the problem is the rate of interest is too high, then we want to lower it because that was the objective. We wanted to lower the rate. And actually, we were doing this to armor the economy against the imprudent politicians.

Because once you dollarize, dollarizing is very simple. People do not understand this. You can dollarize very easily. But if you want to de-dollarize, you know, it is completely different. If I go to you and I say, give me your colones and I'll give you dollars. If I tell you, give me your dollars and I'll give you a token called colones or whatever.

So, people evaluated this more. Also, there was more credibility because the policies that we had put in motion in the previous governments have resulted in lower inflation, higher rate of growth of the economy, and so on. 

Rasheed: I should add, just for some listening context, that the presidents we've been talking about so far, namely Cristiani, Calderoso, and Flores, are all from the same party, plus 15 years of governance under one party whose name is La Alianza Republicana Nacionalista, or just ARENA.

And they had a more, call it Liberalismo, right-wing liberalist type ideology. And that was the 15 years of continuous stabilization of policy preference in El Salvador at that time. 

Now, I'm curious how President Flores approached you to push forward the dollarization program in El Salvador. Did he call you? Was it a long process? How exactly did this conversation happen?

Manuel: That was very funny because I was no longer in the government, there was another Minister of Finance, and I did have a good relationship with President Flores. He said Manuel was working, he was managing the economy, which was not right, you know, you never manage the economy.

So we are going to have more people, in the cabinet discussing these things. And actually, I had to discuss a lot. The cabinet I was in, was full of people with very strong personalities. It was not a situation where everything the president said was accepted. No, there were opposing ideas and discussions, and so on. But then one day he didn't like the idea of dollarization. And that's why I think he said that I was the hair in the soup in the previous government. But then I think that reality hit him. Maybe Manuel is right because the rate of interest didn't go down. And then he called me and he said, come and have breakfast together. And then I went and I had breakfast with him and he said, "Manuel, could you do me a favor? Please. Write a memo. How would you reduce the rate of interest without dollarizing? Without dollarizing. I know that you say that we should dollarize, but don't include that". And then I wrote a memo, very well written, because I was showing and with all the sources and all the information. And then he read it and he said, "you know what, we're going to dollarize."

And then he said, I think we have a good environment now in the National Assembly, so you have one month to draft the law and prepare everything that has to be done. And he appointed a group, a committee, to do it, and we started working. He said, "We have to maintain this in total secret, we are going to dollarize without the project because people will say things". And he was very wise, when doing this, because I can see that in Argentina.

When you say we are going to dollarize, you imagine what dollarization is. You have to say this is it, and in one or two paragraphs explain this is what we are going to do. So that people cannot invent things about it. And people invent things about dollarization, not because they are bad, because they don't know.

And they hear dollarization and they imagine, I don't know. So many things. So we work in my home. 

Rasheed: So who's we at this time? 

Manuel: We were the minister of finance, the president of the central bank, the most prestigious constitutional lawyer in El Salvador, and two lawyers. And then I also included one Argentine economist. And a Chilean economist. 

Rasheed: Why is that? 

Manuel: Because I wanted people from the outside. I wanted to avoid group thinking. . So I wanted to have somebody new to the idea to see how they reacted. So I chose these two foreigners who were very good economists, both of them, but were not involved.

Because of the others, we were all involved in the project. From the beginning, except for the lawyers, and the economists, we were all for it. Okay, let's have somebody who is not for. 

Rasheed: So, you mentioned the president of the central bank was involved. Now, at first blush, it might seem strange that he would want dollarization in El Salvador.

Manuel: Yes, he was a very special person because he understood the problem and he wanted to resolve the problem. He was not defending his position. We face the same problem that you say with the IMF. The people from the IMF visiting the country, which were middle-level people, were totally against it, because of course, that would cut their work by half, but actually, I had the advantage that I had a very good relationship with Stanley Fischer who was the top economist in the IMF. I had access to him, we were friends. And I was a friend also of Larry Saunders, who at the time was the second in the treasury. After that, he became the secretary of the treasury. And so I talked to Stanley Fischer, he, knew better. And he said I think it's a very good idea.

Rasheed: Okay, so from your view, why did the mid-level IMF people, what did they say to say that they didn't like the polarization plan for El Salvador? 

Manuel: Yeah, they said this is a bad idea. You need a currency. And then when you ask them why? "You know that there are blocks in New York that have a GDP higher than El Salvador?

 And you're going to tell me that if we were talking about buildings. They're producing a certain amount of money. This building should have a different currency from the next building. Right?" Why? But I'm not going to accuse them, they were defending their positions,. There was this thing they, El Salvador want to become independent from the IMF in that respect, in the currency, they still don't like it.

Rasheed: Yes, that's true. 

Manuel: Actually, we didn't need permission because we had the dollars. We could use them for whatever purpose we had. And also we, much less, needed something from the United States, but it's good to have this treasury on your side. And then I went to see Larry Saunders and he said, "I wrote my thesis on the possibility of dollarization for a small economy".

Rasheed: I didn't know that. 

Manuel: Yes. I didn't know that either at that moment and so I loved the idea. He said, "I have thought a lot about this and I think it's, it's fantastic". Go ahead. So we pass this through the, it's a very short law, and it is not called the law of dollarization, it is called the law of, like, opening, uh, El Salvador.

Rasheed: Monetary integration? 

Manuel: Yes, monetary integration. Because back at this time, we could see, that there were going to be these international chains of production. Its globalization was already underway. And then if you wanted to integrate into the international economy, you need dollars. Because if, let's say, you think of the production of Minis, the car minis, and then you say, oh, that's a British car.

Yeah, but who is the owner? BMW. Okay. The engine is a BMW engine. But the Injector is manufactured in Poland, and the tires are manufactured in France. So, if you are managing the Mini brand, you cannot be there making cost calculations every day. Wait, now the tires are more expensive. Why? They are more expensive because the franc went up.

And then the injector is less expensive because the Deutschmark went down. You have to have one single currency to keep all your costs under control. And that's the dollar. Here in Europe, it could be the euro, but you need a very strong, widely accepted currency.

Rasheed: So there's a surprising feature of the law that you and your colleagues wrote to dollarize. El Salvador. You never mentioned the word dollarization. You call it monetary integration, but also you never removed the utility or the legality of the domestic currency at the time, the colones. Why was that choice made?

Manuel: We have not, even today, they are not officially removed because this was the president also. I think he was very wise in this because, in Ecuador, they had given a clause saying that after a certain date, a sunset close, the old currency would lapse. And then he said, why? People will go to the dollar.

Let's not do this in any way that people feel forced or that we are forcing them. But what we are going to say, is we were proposing to keep the same exchange rate, which had 10 years. But since we're not inflating the economy, we didn't have to devalue the currency. And, the currency was floating, and it was floating in equilibrium.

So we said, we are going to keep this the same. What was the dollarization? People, for example, in Argentina, they think that the size of the banking system is, I don't know, 4, 000 billion or whatever, 4 billion, 10 billion, that they need all the dollars to make the conversion. You don't need that because the banks do not keep your deposits in envelopes. You deposit your money and then the person who wants to build that building goes there and they lend the money to him. So your money has turned into a building right in front of you. So you don't need dollars to buy that. That building is repaying itself through the use of people living there.

So the only thing that you have to do is you have to replace the dollars, the dollar bills in circulation only, okay? Because those you need, this is a dollar and not a colón. Although, even in Panama, the coins are Panamanian. 

Rasheed: Yeah, Balboas. 

Manuel: They're called Balboas, and the Balboa doesn't exist, okay? But everybody thinks in dollars, but they're called Balboas.

We had to buy all the dollar bills and coins. We decided, let's do it, everything, okay? So we have the dollar bills, which was not a big amount. It was 50 million, I think, something like that. We asked them, and there is a bank, the Bank of New York, that does that for the federal government. 

Rasheed: Okay. Is it the Fed branch in New York?

Manuel: Yeah. I don't know where they have the bills stored. But they do it. The first shipment was a 747 full of bills. But then, you could exchange dollars for colones if you want. Everything in El Salvador was voluntary, but what was commanded by law was that the accounts of the banks would be expressed in dollars from January 1st.

Rasheed: And how was this all coordinated with the commercial banks and the government? Was it a seminar? 

Manuel: That's it. We had seminars and we explained this to them and it's very simple. The law said that all monetary contracts would be expressed in dollars.

So if you were paying 8, 750 colones for rent, now it will be US $1, 000. Now, if the person who is renting the apartment for you said, pay me in colones, that is legal also. Because what we said was all the contracts are valid if they are in any currency. So that's why saying that the bitcoins were becoming a legal tender in El Salvador wasn't necessary because you can use tomatoes, I can lend you 1, 000, 000 tomatoes and then you have to pay me in tomatoes or cucumbers or whatever.

So it's a very open monetary system and with that, with all the contracts in dollars, you cannot be lost. It's very easy. I'm going to pay in dollars, and then most of the transactions in El Salvador were already in credit cards with cheques, bank transfers, and so on. The amount of cash that was used at the time was very small.

Now it's even smaller here in Spain. How much cash do you use? 

Rasheed: I probably have only touched a Euro bill twice. 

Manuel: Yes, you say. So, it's a very simple thing because everything is managed through the banking system. 

Rasheed: I also have a question about this. Did the commercial bank leaders give any pushback to the dollarization plan?

Manuel: The financial leaders? No, we were protected. We didn't want them to know until we took the project to the National Assembly. So, they knew about the project at the same time that the deputies, etc. Because, at the time, the bankers were all against dollarization. In this, they were short-sighted because they were protecting the money they were making in the exchange.

And then we told them, look, you are going to be rich in dollars, something that cannot be devalued. And then they understood. 

Rasheed: So when the law was introduced to the assembly, I assumed there were a lot of calls coming in, perhaps from the different parties and different interest groups. How was that handled?

Because there had to be a lot of anger. 

Manuel: We had a communist party there, and they were furious. But the president, Flores, was a very agreeable man. He convinced them not to oppose. 

Rasheed: How is that possible? It seems, impossible. 

Manuel: What he said was, "Have you realized that we are protecting the trade unions? If you think that the country is in different classes, the rich and the poor. The rich, have their money in New York. So they are protected against devaluations, against any crazy guy coming to the central bank, but the poor are not. Now the poor will be. And the rich, since the rich had dollars, they could borrow at 3 percent or 4 percent in the United States, but the poor, they have to pay 18%."

And he announced that, and we explained this. They didn't want to support it because they thought that the dollar was the money of Satan. But in the end, they didn't oppose. 

Rasheed: I read that at the time when the law was passed, it was only by a simple majority vote, which was not the expected kind of vote needed to pass this kind of very deep trench law. How was this allowed to happen? 

Manuel: Because we were not changing the constitution. That's why we had the constitutional lawyer because you need a higher majority if you are going to change the Constitution. Then it's a special procedure. One National Assembly has to approve it, the next one has to approve it, and then, only then can make the change.

But we were not changing because the Constitution said something like, the government must take care of having a good currency. Something like that. So, that doesn't mean that you had to issue the currency. That means that you have to take care of having a good system working, and it is so well argued, the case, that nobody ever challenged the constitutionality of the change. The FMLN, later, decided that they had been stupid, and they organized protests and so on, but not even they. And then they were in the presidency for 10 years, the first thing that they said when they were in the elections, was, we are not going to de-dollarize.

Rasheed: And I have some questions about that. Okay, so the bill was passed, so eventually the bill was introduced. One month later it was fully passed in assembly, then it came into force. Since November it was passed, and then in January the following year, it came into force quite quickly.

Manuel: Yeah, quite quickly, because as I was telling you, it's very simple, you just divide everything by 8. 75. That's it.

Rasheed: When the bill was passed, do you have a recollection of what the other countries around Central America were saying about the new move in El Salvador? 

Manuel: There were people in Guatemala saying, wow, maybe we should do this, but very promptly that died. 10 years after the fact, more or less, more I think, when the first president of the FMLN came to power, he put in the central bank a real enemy of dollarization.

He had always said. He's an economist. He used technical arguments, which are the same, which are in the PowerPoint. Those are the arguments that if you have your own currency, then you can devalue, and then you promote exports. If this were true, Argentina would be the largest exporter in the world. You know, this kind of argument.

But then he asked the IMF to make an assessment, and of course, they put together a team of people who came to tell you the truth. The guys did a very good job. But in their PowerPoint, the last page of the presentation is taken from a report they wrote.

And they said that due to dollarization the private sector and the government had real savings. Even including the seigniorage net, which was, I think it was something like 0. 75 percent of GDP per year from now to eternity because of the lowering of the financial costs of the country. Even this guy, he was expecting maybe that the IMF would say, yes, you have to de-dollarize.

And the IMF said that we had managed the crisis, the 2008 crisis, better than the rest of the countries in Central America. And I know that because of the World Bank, I was no longer with the World Bank, but I did some consultancy for them. And then the World Bank asked me to go around Central America, including Panama, to see how they were managing the 2008 crisis. And then, of course, in Panama, we don't have any problem, like in El Salvador. And I remember I was good friends with the president of the Central Bank of Costa Rica. And then I came into his office smiling and, hello, how are you? And he was overwhelmed. He said, wow, I can see the difference between being dollarized and not.

Because he said, we are here and we don't know what to do, devalue or appreciate, like, what do we do? And I say we go to the beach because the market manages this. 

Rasheed: Okay. So did the dollarization of Ecuador give any political coverage, you think, in El Salvador for Flores to push forward his plan?

Manuel: Well, there is a lady, Joyce De Ginatta, who was one of the people who supported dollarization in Ecuador, which was one year before.

And we were friends. She was the president of the Small Enterprise Association in Ecuador. And in El Salvador, the small enterprises were very concerned. They didn't know what would happen to them. We gave them seminars, but still, so we brought her. She spent almost one month in El Salvador talking to small enterprises and explaining how this has worked in Ecuador.

She was very helpful. 

Rasheed: Okay, so now. El Salvador is dollarized. This is 2001. 

Manuel: And the rate of interest went down immediately. And the duration of the loans was expanded. In El Salvador, you could borrow to build your house at 18 percent and five years. It's the market, it was very small, and the government had to subsidize people so that they could buy their houses.

But then the mortgage rate went down to six, six and a half percent, and the maturity went up to 25 to 30 years, but it was in three months. And since then, including the time of the crisis, because many people say the first crisis, El Salvador goes. And even including the crisis, maybe the interest rate went up from six and a half to seven percent.

Nothing, really, but still now it is about six and a half and seven percent in this moment. 

Rasheed: This idea of long-term credit is so dramatically overlooked when people talk about Latin America. As I mentioned, I lived in Panama, and my husband and I have a house in Panama, and the mortgage rate is two percent for 30 years. That is unheard of across Latin America. And for us it's like, yeah, that's Panama. It's normal for Panama. But people don't get how that is so important for long-term growth. 

Manuel: Yes, that's right. This is important. And even El Salvador has a lot of other risks at this moment.

El Salvador, the NBI, in the secondary market of bonds, El Salvador is like a pariah. It has been at the level of Argentina. It's in a very bad credit situation, the government. So I have only this scene to explain this. The minister of finance is with his secretary and he is complaining, you know, we cannot get money in the international markets.

They are saying that maybe they will lend us money for 18%. We cannot survive this. And then the secretary said, "Mr. Minister, this is very interesting, but could you allow me to leave now because I have to go to the bank because I'm going to sign a new loan for an apartment at 6 percent for 30 years."

Because then, you know, what is the difference in any other country, if you have the government or Latin American country, you have the government in this condition, the interest rate paid by the private sector will be even higher because that's the thing. They always say the best borrower is always the government, so the interest rate has to be higher than the other.

Why is it? Because people know that the government if they are issuing their own currency, they will use their own currency to do tricks and devalue it, and so on. They will introduce monetary disorder just because their debt is very high. Not in El Salvador. Because they cannot manipulate the dollars.

Rasheed: Now, Manuel. I would like to transition to talking about some of more theoretical problems and objections when it comes to dollarization. It seems to me like one of the most common theoretical objections to dollarization is the idea that the central banking function as a lender of last resort would go away.

And therefore that would be a bad thing for especially small economies that should have this lender of last resort function. So you have countries like Panama, El Salvador, and Ecuador, that do not have any central bank, so they do not have any, it would appear lender of last resort. But they don't seem to be having that much of a problem.

Is it true that a lender of last resort is necessary for small open economies like the ones I listed or any other small open economies? 

Manuel: There is indeed no domestic lender of last resort, El Salvador or Panama or Ecuador, but that's the same situation in Argentina, Chile, Mexico, and in all the countries that have their currency.

It's only that they have hidden that problem, because who is the lender of last resort for El Salvador? The IMF. Who is the lender of last resort for Argentina? The IMF. Because when you have a crisis, people go for dollars, because in countries, weak countries, we cannot say small countries because Switzerland is a small country, but Switzerland has a rock-solid currency.

But if you live in Latin America, people think in dollars. That's it. You know, you translate everything into dollars to measure the risks or the value of the currency and so on. And this is what happened in Ecuador, for example. In Ecuador, there is a graph of the deposits in Ecuador going down.

But then, when they dollarized, the deposits started going up again. Because in Latin America all the crises that you have, the banking crisis that you have, started with a currency crisis, all of them. Argentina back when the currency board came down, it was a currency crisis because people took money out of the banks, the pesos out of the bank to buy dollars.

Rasheed: See, that's a point people don't seem to understand because if you're American, you assume the functionality of a crisis works the same way. 

Manuel: Exactly. If you are an American, you don't realize that things are different in other countries, that in other countries, I discussed this in this book, it is completely different, the monetary theory that you have to apply when your trust is in your currency or your trust is in another country's currency. When you print money, let's say that we are in Argentina, and we print money, we print pesos. The central bank cannot print dollars, only pesos. But then, every time that you print pesos, for the same reason why that increases domestic demand, increases your demand for imports. 

But then the demand for the transportation of the ships goes up, and that is oil. We don't produce oil. The demand for trucks goes up. We don't produce trucks. So every time that you increase your domestic demand, the demand for imported inputs goes up. And for that, you need dollars. So when the central bank prints pesos, their deposit, their reserves in dollars go down.

And if they keep on doing that, as in Argentina, you run out of dollars and then you have to go to the real lender of last resort, which is the IMF. That's why Argentina is the largest borrower of the IMF in the entire world. If they think that if you have a central bank that prints your own money, then the ministers, the president of the central bank and the minister of finance of a country in crisis in Latin America, for example, they tell them, look, we have a run on the banking system.

They would say, okay, all right. I'll go to the beach, and it's, uh, please bring me the car, so Why? Because then you will say, okay, people are running the banks, and then I only have to print pesos, and people will be happy. No way. People will take that, they will exchange it into dollars, and the dollar reserves will go down.

And then if you don't have reserves, you cannot import anything, and then the currency enters into a crisis like the one in Ecuador and the one in Argentina. So, it is not true that the central bank is the lender of last resort. It is true in the United States, okay? They produce most of the economic theory. And that's the problem.

Also, the British, can produce pounds, and many people will take pounds in Barbados or El Salvador, they would take pounds. But they are not going to take Argentinian pesos. The problem is that most economic theory is produced in countries, mainly the United States or Europe. If in Europe they have a problem with the money, they can print a lot of euros.

People will take them. In Argentina, they won't take it. They will take them and they will exchange them for dollars. That's completely different. 

Rasheed: Another common objection to the dollarization Manuel is the idea that the government should retain the power of currency devaluation. And the argument here is that if you have that power, you can operate some kind of economic fine-tuning, or say, some idea of fiscal-laden monetary policy.

Now that argument has two parts, of course, generally speaking, devaluation, that's what they mean, but then the slightly deeper aspect of it is when you do current devaluation, of course, you can't really change the import prices because those are set internationally and not domestically. But when you do devaluation is in fact, you simply reduce real wages.

Now, even if you were willing to make the trade-off of reducing domestic real wages, is that worth it? Does devaluation aid economic growth? 

Manuel: People who say that, forget that there is a theorem in economics, which is that you cannot change your terms of exchange. They don't know that, because that is a theorem in trade theory.

And I have noticed that there are economists who maybe know something about finance, but they don't know anything about international trade. It's all about industrial policy, or people becoming very specialized. But this is very easy to show that if you produce, let's say, coffee, and you face the United States, who is producing, which is producing software, and then the value of software is 20 times higher than the value of coffee that just by reducing the value of your currency, you will be able to improve your economy to the point that you will be at the same level than the United States just by devaluing the currency that goes against what you are seeing, what you are seeing in Argentina, what you are seeing all these places.

That's number one. Number two. What does devaluation do? In all economies, we have two kinds of goods. There are tradable goods, whose price is determined in the international markets. Like cars, like computers, like telephones, etc. These kinds of things can be traded, the government cannot affect the price of these things after you reduce everything to one common currency.

It's impossible. You cannot take your, let's say $1000 telephone, and you say, I'm going to make it cheaper here in El Salvador. I'm going to devalue the currency by half. And then this thing will be half the price. You are crazy. Immediately the price will adjust for the devaluation. You cannot affect those prices, what are the prices that you can affect with that evaluation? The non-tradable, are the things where the prices determined inside the economy, and the most important of that is your wage. Working in El Salvador is determined here in El Salvador. Okay. So, when you devalue the currency, the price in the domestic currency of the imported inputs or whatever tradable we are talking about will increase immediately.

So, what will be reduced? The one that will be reduced is your wage. And actually, what I am saying is the basis for the idea that exports increase when you devalue the currency, because they say you are devaluing your real wage, you are reducing. Is that a problem to establish to say I'm helping my country because I am reducing the salary of the wage earners?

That's not a good way to that's why immediately the trade unions react and they say adjust for devaluation because people are not stupid. It's the economists who believe that this can happen. It doesn't. And then you go into this vicious circle. Then you devalue the currency and then the trade unions say adjust me for that.

And then after this happens in Argentina, this happens in any case in which you end up Actually, I have, I think, a few paragraphs on this about demagogo, you know, in this, in which the guy says, and now I am devaluing at the same rate as inflation. So I am in the same situation as if I had zero inflation, but with incredibly more cost because adjusting , it has a real cost. This is just an illusion that you can, as I said about the exports, if it were true that you can adjust these things with fine-tuning, then America would be the richest region in the world if they do it continuously. Besides I don't believe in fine-tuning, only people who don't know how the economy believe in fine-tuning. These people, if they do this, they say the rate of growth will go up from 3.25 to 3.25 and a half. Come on, economics is a rough art.

Rasheed: Moving on to the next objection, which I think I could describe it as the most academic of all of them so far, is the idea of the optimal currency area. And for a very broad view of it, one important property that's usually used in this conversation is the idea that similar business cycles should have similar currencies.

It's a very dulled-down version of the OCA (optimum currency area) theory. But does that idea hold in your opinion?

Manuel: Let's recognize that the view of the central bankers and your view regarding currency are opposite because what could you ask of a currency? Do you want the stability? You want the possibility of using this currency because it is good in time and geographically it keeps its value in time and also geographically. No, said the people in the central bank, because if we have one of these, we cannot manipulate it. And the central banks start from the point that they can fine tune. Okay, we are going to increase the rate of interest by two points. And they never do it in Latin America.

In the United States, they can do it, but in Latin America, they don't do it, because also the central bankers in Latin America and the small countries, they don't really make monetary policy. Why? I explained it before, when I was telling you that in El Salvador the central bank could not lower the interest rates because then the money left the country.

If you have a competitor, like the United States, and people are thinking always in terms of dollars, if you say, okay, we are going to improve this. And we are going to lower the interest rate because the cycle here allows me to do that. We are going down, so let's lower the interest rates. Let's send people some money and take them to Miami or to Panama.

Then, naturally, the market will increase the interest rates again. Besides that, this was just a footnote, but then let's assume that they could do that. How is it that they would be able to take you where so that you wouldn't be able to do anything but obey what the central bank is.

You have to close your economy totally, okay? And then how can you close your economy totally in the globalized world? How? It's impossible. But still, they want to have you so they are going to say, I want to make you increase your deposits in here or reduce their deposits and so on because I'm going to manipulate the currency.

Look at Latin America, they have done that and look at the disasters they have created. That is for them the optimal currency area. An area in which all people are behaving similarly so that with a measure you can manipulate them. All right, have you thought of what it means if you are producing, for example, coffee, which is highly seasonal, and then there is a small sprout of industry in your country, which is not seasonal, it will follow the season of the United States, because you are exporting to the United States. This is a small thing is important to the United States. And then another, which these are desirable things. Another one is producing software for homes in Europe, but that's bad. That means that. From this day on, when you have developed in El Salvador, for example, our exports, 70%, 80% of our exports are industrial.

So we follow the cycle of the United States because we export to the United States or to countries that export to the United States. And the other 30 percent have coffee, and who buys the coffee in the United States? But then let's suppose that there are these new companies producing software for Europe and suppose that Europe and the United States are different, does that mean that you will start printing two currencies?

Follow the logic. . If now El Salvador has one part that follows the cycle of the United States and another part that follows the cycle of Europe and the currency, each different cycle should have a currency. It somehow needs two currencies. That's it. Or not. 

Rasheed: It would be logic, yes. 

Manuel: It leads you to the absurd if you take that logic.

What is the optimal currency area? Is the area of the currency, already existing currency, that is accepted all over the world, and also the one that will keep your financial savings longer without losing value. This is what you, Rasheed, want. This is what you want. You want a trustable currency, that you can exchange in any place in the world, and that if you are going to say, I'm going to save for my old age, you want to have a stable currency.

Not a currency that the central bank will be playing with it. No, no, no, we have to lower the value of the currency. 

Rasheed: So yes, I think those are like humane objections, and you've explained why they're not really good objections. So, I want to go forward now to essentially 2023, 2024. And you have two things in particular.

First, I guess 2022, when in El Salvador, you mentioned, the crypto law, Bitcoin, and so on, the current president of Bukele decided to make a new law to create Bitcoin in particular as an explicit legal tender in El Salvador, where it didn't seem like it was necessary to do. I'm wondering, why do you think the president of the administration even went to do that, given it's already dollarized, and the quality of money is not bad, what was the rationale for this?

Manuel: This is a publicity. I, I think it's to project an image in El Salvador and the president is a very modern person who is in cryptocurrency and so on. Now, if you visit El Salvador, you will say, where are the bitcoins? There are no Bitcoins. Nobody accepts Bitcoin. Maybe there are some, there is something called, I think, the Bitcoin beach, or something like that, and then you can buy a beer.

But, if you go to any other place, if you want to buy a house and pay with Bitcoins, people will say, I'm no longer selling my house. I know a lot of professionals who say, I'm sorry I told you that I was going to see you today but because of course it is not a currency, it changes value from one day to from one hour to the next.

And there are other reasons. Well, El Salvador invested something like 300 million dollars. We don't know how much, because you know that in El Salvador, the president passed a law saying that the government doesn't have to produce any accounts. Even with the Freedom of Information Act, they forgot about that, and now the government doesn't have to give accounts.

So you don't know how much. And then the president has the number of the account in bitcoins. 

Rasheed: Is that legal? 

Manuel: No, it's legal in the sense that they don't have to produce to inform anything. So it's legal. It's not legitimate, of course, and it goes against the Constitution and so on. So it's not legal, but formally they show you a law that they produced saying that they don't have to give accounts.

Also, you cannot accuse any person in the government of corruption. It's illegal. It's illegal because for seven years, they don't have to produce any number of data, and only he can accuse, only the president can accuse his people, of course, but they don't produce numbers and so on. 

So the other thing is, I think that the president believed that by doing this, he would project a great image. And many of these people who are around Bitcoin probably told him we are going to bring enormous amounts of money but those enormous amounts of money never appeared. 

Rasheed: Has Bukele made any consistent disparaging remarks about dollarization as keeping him from doing some kind of fiscal policy?

Manuel: I don't think that he goes into the reality of economic things. It's the image, that he's looking at. And then he says that Bitcoin is fantastic and so on, but there are no Bitcoins. And only people outside of El Salvador think that people are trading in Bitcoins in El Salvador. They are not. Some people buy bitcoins and so on, but then you will see this like dollars.

Rasheed: We've mentioned Argentina a few times in this conversation so far. I want to discuss that a bit more explicitly now. Of course, as we know, Argentina's recently elected president, Millet, has indicated, at least on the campaign, that he had planned to dollarize Argentina urgently. And now that he is the president this has seemed to become pushed on the back burner a bit. Has any of the Millet economic team contacted you about dollarization plans in Argentina at any point in time? 

Manuel: Yes, I was in conversation with two people. Who were on the original team. Ocampo, who was going to be the president of the Central Bank, and I don't know exactly how to pronounce, Nicolás Cachanosky.

Rasheed:  Cachanosky. 

Manuel: Okay. That was very nice. They wrote a book about four or five years ago, I think. I don't remember. And when they were writing it, they called me several times and we had discussions. And then they told me that there was this possibility that Milaei could dollarize Argentina. And that very rapidly became almost a reality.

I never thought. that this was going to happen because I think that they need to dollarize in Argentina. Of course, people say, but it's not the only solution. No, of course not. If you have discipline, you can do it without dollarization. We did that without dollarization. But I don't think that they are going to do it because the corruption around all these financial things is too much. By this corruption I'm not just talking about people who are taking money out of this, but the corruption of thoughts. They have all these ideas, strange ideas. It's what they are doing now. And they say, we are going to do this, and then they say that they are going to change one interest rate here, and this will produce tremendous impact.

And they don't have any solid, simple solution. I think that economics is so complex that you really need solid, simple solutions so that everybody can understand what you're going to do. . But then, Milei fired Ocampo, and Nicholas went with him, and then he appointed Caputo.

Caputo is the one who engineered this problem, the last stage of this problem, he was the engineer of this and he's going to solve the problem. So it's a pity because I think that Argentina could solve very easily the, relatively speaking, very easily the problems of the balance, economic balance. Without equilibrium, you are not going to solve any problem.

So I think they should give priority to stabilizing and then after that, do other things. 

Rasheed: Yeah, they're trying to do the reverse, it seems like. 

Manuel: Yes, it's a very bad idea. You asked me, why is it that you dropped dollarization when you had to concentrate on it, and I told you basically because we were already in equilibrium.

So we could wait for that and do the other things. It's like you're a physician and they bring a patient and the patient is bleeding. You have to stop the that, that is your first, but if the guy is no longer bleeding, then you can start doing other things. And then later on, you do the, let's say the plastic surgery needed to improve the thing so that the guy could be in a better situation.

But now in Argentina, the thing is this, and that's one thing. And the other thing is, Milei is so aggressive. I don't think that's the way to do things. People will just reject it, just by the way he treats people. 

Rasheed: In El Salvador again, has there been any reduction in support from the population for dollarization recently, or is it still as strong as it has always been?

Manuel: Dollarization was an issue in the first one or two years. Now people just take it for granted. There's no discussion of this. 

Rasheed: Yeah, I guess it's the same as Panama, but Panama has a much longer history. Yes, they have a century. Yeah, but no one even ponders the idea of not having dollars anymore.

Thank you so much, Manuel, for this very insightful interview. 

Manuel: Thanks to you. It's a pleasure, Rasheed.

Rasheed: That's it for this episode. For updates about the podcast, please subscribe to our Substack blog found on cpsi.media. You can also read our newsletters and long-form content on Caribbean policy improvements.