Lots More with Brad Setser

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1:01Acrobat Studio. Learn more at adobe.com slash do that with Acrobat. Hey Brad. I didn't realize you were going to be in person. I didn't realize you were going to be in person. I thought you were like. And normally we're just disembodied voices. Singing country tunes from some undisclosed Texas location. I wish. Oh my God. I did a deadlift. One, two, three. Hegemony. Okay, go. Hegemony. Barges. This is an after-school special, except... I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the U.S. Where's the best squid ink pasta? These are the important questions.

1:46Is it robots taking over the world? No, I think that, like, in a couple of years, the AI will do a really good job of making the Odlots podcast. and people are like, I don't really need to listen to Joe and Tracy anymore. We do have the perfect guest. Until then, this is lots more. A weekly chat about whatever's on our minds. And we really do have the perfect guest.

2:14Do you recall the first time we talked about Argentina? Yes. Worst decision of my life. No, not at all. The worst, without a question, the worst interview I've done as being interviewed. The biggest bomb I've ever had. Will you tell me the story? Yes. So it was 2006, probably, maybe 2007, 2006. I think it was 2005. Maybe it was 2005. I was living in New York. I was more or less unemployed. I think I was doing, like, you know, temp work or something like that. And I saw an ad online, I forget where, that the Rubini Global Economics was hiring for someone to do economic analysis. And I was like, I need a job and I'm kind of interested in economics.

3:01I just stopped a job that I had working for a small portfolio management company. And so I sent an email and I'm like, I think I've studied a little economics and maybe I could do this. And I went to an office on the lower west side. I think it was Tribeca. Was that where it was, Brad? Somewhere around there. It was north of Tribeca. Okay. There's a warehouse. It's off to the west of Soho. I met with Brad. I was applying for the job. I met with Brad. I knew actually in advance of this interview that Brad was interested in Argentina specifically and all the problems that it had. And I tried to cram the day before to learn something about Argentina.

3:42and I think the first question Brad asked me something about how you know what would some policy prescription I'd have for that and you know that experience like if you're trying to speak a foreign language that you used to know 15 years ago and you think maybe you know it and your mouth opens but nothing comes out that was me I also know the experience of like having a bad interview in real time and you realize that it's going terribly oh it's just like the mouth opens and it's like no words came out and I'm like well I guess I'm gonna do something else. Anyway, it worked out. We should have hired you on the strength of your blog alone.

4:17Anyway. Bad business model. Anyway. We should have recognized we should have moved to meet the talent where the talent was. 18 years later, here we are. 17 years later, here we are. And people are still talking about Argentina. Yeah. Well, we are here with Brad Setzer, a senior fellow at the Council on Foreign Relations. He's been on the show multiple times. Many times. He's got to be he might be the number one now. I don't know. I'm sure I've been eclipsed. I was out of commission for two years. Yeah, that's true. When Brad was at Treasury, there were a couple years where we didn't get a chance to speak to him, but it's been a lot now.

4:58But, to your point, Joe, it always feels like deja vu with Argentina. It's either they've just defaulted on bonds because someone decided to give them money again for reasons I don't understand, or something kind of crazy is happening. Like with Argentina, it just feels like the craziest outcome is like the one that tends to happen. And the thing is, too, Tracy, is that all these years later, I actually still have no conceptual understanding of what's actually the problem with the Argentine economy. I don't understand why, you know, several years ago, I think they elected some pretty like normie, reasonably centrist, neoliberal president.

5:39And I was like, oh, he's going to shake hands with Wall Street and here. And it didn't work. And, you know, and so I don't really understand. I don't know what Peronism is exactly. I'm not sure anyone totally does. I don't know why there's this perpetual seeming basket case that has rapid inflation. After all these years, I would bomb another interview if I were being asked any Argentina question. And I've gotten good at BSing on other topics. But even though I can't even begin to BS on Argentina. Brad, what's your summation of the Argentine economy? Like if Joe was interviewing you for a job, what would you say?

6:14Oh, well, I have a thesis. It may be a wrong thesis, but it is it's an economy with a very small banking system. So it has difficulty financing fiscal deficits domestically. It tends, therefore, to try to borrow a lot externally. And it has a relatively small export sector, very ag-based, with a lot of volatile export revenues. And it tends to overborrow relative to its export capacity. And when you can't borrow externally, it tends to print money. So you get this combination of default inflation and periods of stability. And all of that definitely makes sense when you spell it out like that. But it also seems like, doesn't that apply to a bunch of countries, like, you know, not a very depthful domestic financial system, commodity exporters, so obviously exposed to very volatile.

7:02Like, aren't a lot of countries in this predicament? And why does it seem like Argentina specifically, people think it theoretically can get out of it, but it just can't? Why is it? It seems to just keep tripping over itself. Well, I think actually compared to most other commodity exporters, like commodity exports as a share of GDP aren't all that high. It's just there's very few manufactured exports. So it's a relatively low level of commodity exports relative to the size of the economy. And I think people tend to think that because it's a relatively big economy, it can support more debt than it can given these constraints.

7:43So that's kind of my thesis. But, you know, there are countries around it that have commodity-dependent economies. More mining, less ag. Like Chile. Like Chile, copper. But a much more stable. But a much bigger export base and less debt. And they've built up over time monetary policy credibility in a way that, you know, boringly in Argentina has not very clearly. OK, so this feeds into my big question here. Why do people keep giving Argentina money? Because this is like a joke in the market. And I think I tweeted this once. but the distracted boyfriend meme, you know, turning away from defaulted Argentina bonds and looking at more Argentina bonds.

8:25And also, I didn't realize this, but Argentina is the IMF's biggest creditor now, which. Well, they owe more to the IMF. Let me restay that. If they were the IMF's biggest creditor, we'd be in a very different situation. The biggest debtor. But you know what they say about debtors? If you're big enough, you kind of. They're not big enough, I guess. They're plenty big enough. Okay, so why do they keep getting money? Well, actually, Argentina didn't get money for a long time after their 2001-2002 default. They did eventually do a restructuring. It took a while. And then after they did the restructuring, there were a lot of holdouts.

9:03And they really didn't regain market access for a long period. And then, you know, Joe's right. I mean, a centrist, relatively center-right, really, maybe more right than center-right. President was elected, President Macri. He brought in a bunch of Wall Street bankers to run his economic team. And they had a clear theory of the case that Argentina had underborrowed. They would settle with the holdouts. They would go out and raise a certain amount of bonds that would cover fiscal deficits associated with tax cuts, like a very conventional center-right to right agenda. finance with external foreign currency borrowing.

9:42And they went out and they did a lot of that. But apart from that one borrowing spree, which was big, like$40,$50 billion and maybe more in two years, Argentina really hasn't had access to external bond markets. But then, you know, the IMF saw a group of non-Paranist reformers struggling and it gave them a... Structural reform. They were, you know, they were backing certain structural reforms. Macri was friends with Donald J. Trump. They came from real estate development families. He got a big IMF loan. But then the current government, the previous government had borrowed so much from the IMF, they've not had access to new money.

10:22They clearly don't have access to the bond market. Their bonds have been trading in between 20 and 40 cents on the dollar ever since the 2020 restructuring. So obviously, we want to talk about the theoretical economic agenda of the president-elect and his talk about dollarization. But just real quickly, before we sort of get to the present moment, what failed about the mockery plan? Like when he, you know, as you said, it sounded sort of normal on paper and standard, maybe, you know, conservative government staffed with Wall Street friendly types. Why didn't that put the country on a new path?

10:56I think he just borrowed too much. So it's just a conservative version of the same old problem. I mean, I think if you were going to fund a big tax cut, you know, his thesis was you would, you know, provide the sugar before you do the tough structural reform. The sugar was a round of tax cuts and they were going to slowly phase in spending, protecting social spending. So the first effect was a bigger deficit, fully financed by external foreign currency borrowing and the market. And I guess the Macri government overestimated their capacity to sustain a higher level of external debt. And sort of things went downhill.

11:34There was, you know, the standard cyclical fluctuations, which made it hard to bring the fiscal deficit back down. And they were reluctant to do brutal cuts because they thought they would lose the election. And if they lost the election, we'd be back in Peronism. We would surely have a default. But it ended up adding clearly like$100 billion to Argentina's external debt in a four-year period. I shouldn't laugh, but it's something grim about it. I mean, it was a stunning spree of external borrowing. And, you know, they didn't want to let the currency weaken too much because they were worried about inflation.

12:07Right. So the current account was not helping them. And so, you know, I think they just borrowed too much, to be honest. You can fund tax cuts if you can fund them domestically, but funding them with external dollars when you're a dollar-constrained economy is risky.

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13:51Go to public.com slash market and earn an uncapped 1 % bonus when you transfer your portfolio. That's public.com slash market. Paid for by Public Investing. All investing involves the risk of loss, including loss of principal. Brokered services for U.S.-listed registered securities, options, and bonds in a self-directed account are offered by Public Investing, Inc., member FINRA, and SIPC. Crypto trading provided by XeroHash. Complete disclosures available at public.com slash disclosures. We're recording this on November 29th, and I feel like I have to caveat the conversation with the exact date because things move fast in Argentina.

14:27And in fact, I'm looking on the Bloomberg terminal now, and it looks like the new president, Javier Millet, has just picked his economy czar. And it's someone who I think wasn't the frontrunner like a week or two ago. Anyway, we wanted to talk to Brad about dollarization. and I don't know much about this process. I am very willing to admit. I think it's happened in like Panama and Ecuador, but can you talk generally to begin with, like what does dollarization actually mean? I think you can think of dollarization as two things. One, it's just a buyback of your own currency. People have currency in circulation bills.

15:13You buy them back and you give them dollars. Euro-ization in the euro area becomes the legal currency that settles all transactions. If the dollar is the legal currency settling all transactions, then debts that were previously in your local currency also have to be re-denominated into dollars. So the second component is a re-denomination of debt into dollars. And so you combine those two things. Dollars have replaced currency in circulation. Dollars are legal tender. and your debts are in dollars. You've dollarized. What's the problem that you're actually trying to solve? Usually you're trying to solve a problem of inflation that you're trying, you basically need to tie your hands.

15:55It's like Odysseus going through the straits with the sirens, you know, lashing himself to the mass and will not be tempted to print money. You have no capacity to print money. So if you want to spend money, you got to raise money. You know, you have to raise hard dollars to fund domestic spending. It sounds like you need money to do this as well, though. Like the idea of replacing your existing currency, so I guess in this case, the Argentine peso with the dollar, you would need dollars in order to do that. That is a very important insight, Tracy. Thank you. That is one of the problems that Argentina faces.

16:36They're trying to dollarize, and the central bank is out of dollars, which is an interesting theoretical problem. So this new incoming president, Javier Mille, he said he wants to dollarize. He's also talked about getting rid of the central bank. Of course, we don't know what he's going to do. And it's possible that he sort of ends up governing the country as a sort of standard. Well, he's kind of going back and forth. Yeah, conservative, you know, center right, Latin American president, as, you know, often countries go back and forth between left and right. Like, I get that impulse, actually, which is that, you know, if your country has a pattern of just printing too much money historically, then you solve the problem by essentially throwing away the printing press.

17:16There's literally no way Argentina can print dollars, dollars are pretty stable. Is there a path to doing that given the lack of dollars? Not unless a generous benefactor were willing to lend Argentina a bunch of dollars. Is it the IMF again? Sorry. Well, I don't think the IMF is actually willing to provide the dollars. I mean, I think the IMF believes that it needs to finally get a little money back. But, you know, conceptually, it could be the IMF. It could be the United States. It could be private Argentines who have a lot of dollars offshore who band together and provide a generous loan. But Argentina doesn't actually have the capacity to pay very much interest on the dollars it borrows, given how much it's paying on this existing dollar debt.

18:00So there are some real challenges coming up with the dollars, which is probably why Malay is at least, you know, the last I had read, he said that dollarization is a goal. He said it's something that doesn't need to be accomplished on day one. They're not going to, in the first instance, shut down the central bank. And their first move, supposedly, last I saw, was going to be, as Joe suggested, a sort of standard but harsh fiscal consolidation, budget tightening, which is also just a reflection of reality at this point. Argentina cannot finance its fiscal deficits right now. Brad, you know, you mentioned earlier that the Argentina economy is sort of characterized by a small banking system.

18:46Would dollarization help with expanding the financial system in the sense that like maybe you're encouraging more faith in the money and that would translate into more willingness to actually put money into bank deposits and then banks would be able to lend more? So there are two, I think, offsetting effects. One is, at least in theory, there are a lot of dollars in circulation in Argentina, a lot of dollars locked up in safe deposit box. The black market. Well, it's black market plus, you know, some wealthy Argentines, just rather than trusting the banking system, you know, have a certain number of dollars in Miami and a certain number of dollars under the mattress.

19:29So there are dollars in circulation, the black market. there are dollars under the mattress, and then there are offshore dollars in the offshore banking system. Conceptually, some of those dollars could migrate into the domestic banking system, which would expand the deposit base, allow the banks to lend more. They have to lend more in dollars, and they could conceivably provide more dollar financing to the government. So that's kind of effect A. Effect B is that you really don't have a lender of last resort. So banks are in the business of maturity transformation, particularly if you don't have a printing press, if you don't have your own central bank.

20:13So if depositors ever want their deposits back, you have to provide them with dollars cash. So either you get those dollars from your central bank, again, the central bank doesn't have dollars, or you have to hold as assets a lot of offshore dollars. So it tends to have offsetting effects. If it worked, it could bring money into the banking system. If it doesn't work, you will have converted a bunch of peso deposits into dollars. people will show up and ask for their dollars back and the banks will be unable to honor those dollar promises and you'll end up with a frozen banking system. Are there other ways besides dollarization in which, I mean, because you're trying to solve an institutional problem and, you know, I love the analogy of tying yourself to the mast and so you don't have the temptation to do anything.

21:08Are there other examples either historically or around the world where countries solve the institutional problem of essentially self-constrained other than sort of dollarization, which seems kind of off the table without the dollars. So you can do various forms of pegs, which are just sort of softer. Yeah. But you know. But you can always break a peg. You can always break a peg. You can do various, you know. I guess you can always undollarize too. It's hard to, it's harder to undollarize. But you know, it is conceptually, I mean, remember Argentina got off a currency board. Right. Which was supposed to be the.

21:42Is a board and a peg basically the same thing? A board is you fully back all currency in circulation with dollars or whatever you're pegged to. So anyone who has a peso could get a dollar, and those dollars are available at the central bank. Now, it doesn't solve the problem of a lender of last resort to the government or to the banking system, but it means every peso is backed by a dollar at the central bank. So it is more constraining in that respect. You know, a peg is a function of credibility. Yeah. And if you're really, really, really committed to the peg, and if you have a really tight budget, you could conceivably make it work.

22:19But it's basically, ultimately, it hinges on fiscal discipline. I mean, this kind of goes back to being boring. Tracy, I'm just looking on the terminal. You know, you mentioned the new finance minister. The title, our colleague Sebastian Boyd, who outwrote it, one of our great colleagues, Millet picks architect of Argentine borrowing boom to run economy. And then Caputo was the finance minister for Mauricio Macri and ran the negotiations with bondholders that paved the way for a return to international markets in 2016. So this just proves my point that like the craziest outcome is always like what's going to happen with Argentina.

22:55What's the scorecard for dollarization in places where it's actually happened? So I mentioned Ecuador and Panama, and I see like different interpretations of the success of those programs. So some people look at Ecuador and say, well, Ecuador growth is still relatively sluggish, whereas Panama has boomed. But with Panama, it's hard to kind of disentangle the factor of the Panama Canal and having like an offshore financial center and things like that. So how would you evaluate the success of previous dollarization programs? So, yeah, I've spent more time thinking about Ecuador than Panama. I would tend to think that Panama's success is a function, probably less of the canal and more of being an offshore financial center and the Panama Papers and a set of less savory aspects of contemporary globalization, which are probably they are facilitated by doing business in dollars.

23:51I mean, presumably some Argentines have their offshore dollars in banks in Panama. With Ecuador, look, Ecuador has stuck by dollarization. So in that narrow sense, it is worked. The banking system has not imploded. There have not been runs. Ecuador has not grown especially rapidly compared to its Andean peers that have not dollarized. Colombia, Peru, Chile have generally outperformed Ecuador. And Ecuador, rather clearly, and this is, I think, an important principle, dollarization doesn't end the risk of default. And when oil prices go down, Ecuador still regularly defaults. So there have been multiple defaults after Ecuador dollarized.

24:34So I think the record is a little bit mixed. Certainly, if you can pull it off, having your own stable currency, which you can use to denominate bank accounts and most of your own borrowing, is a better, clearer path to stability, particularly if you have a limited export base. Thank you.

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