How does Chile’s measure land values using different currency mechanisms ?

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Chile measures land values using different currency mechanisms

This post introduces a modern example of medium-unit divergence: the Chilean peso and Chile’s Unidad de Fomento or UF

Like most modern currencies, the peso is issued by the nation’s central bank, the Banco Central de Chile. Local banks offer peso-denominated cheques and savings accounts. Chileans use these pesos as the nation’s medium of exchange. They pay their bills with pesos, settle rent, and buy food.

The differences between Chile’s monetary system and those of other nations only emerge when we begin looking at the unit in which goods are priced. Most nations have one unit of account, but Chile has two. While many Chilean prices are expressed in terms of the peso, or P, a broad range of prices is expressed in an entirely different unit, the Unidad de Fomento, or UF. Real estate, rent, mortgages, car loans, long-term government securities, taxes, pension payments, and alimony are all priced using UF.

On the other hand, wages, consumer goods prices, and stock prices are expressed in peso terms.

So what is the UF? The UF was introduced in 1967 by the Chilean government, though it only came into wide use as a unit of account in the 1980s. No UF coins or notes are circulating in the Chilean economy. Rather, the Unidad de Fomento exists as a purely abstract, or indexed, unit-of-account, totally divorced from any media of exchange. Goods and services quoted in the UF can only be purchased with an entirely different medium — pesos.

The UF is defined as the number of currency units, or pesos, necessary for Chileans to buy a representative basket of consumer goods. The amount of pesos in one UF, or the peso-to-UF exchange rate, is calculated daily and is published on Banco Central’s website. The daily value is interpolated from the previous month’s consumer price index, or the Indice de Precios al Consumidor (IPC). If you go to this website, you can see the current peso-to-UF rate and how it has been adjusted over the last week.

This all sounds quite odd, so let’s use an example to better understand how the system functions. When a Chilean seller prices something in UF, they indicate that they expect to receive a fixed quantity of CPI basket-equivalents as payment. For instance, say that a landlord advertises an apartment in downtown Santiago at a monthly rate of 10 UF. A potential renter, curious about the price, checks the UF-to-peso exchange rate on the central bank’s website. He sees that today’s rate stands at 23,000. Using a cellphone app, he multiplies 10 UF x 23,000 P/UF to arrive at the current monthly rate in pesos, or 230,000P (this is about US$450). Deciding that the price is good, the renter signs a lease and starts to pay UF-denominated rent each month in pesos.

Say that Banco Central adopts an easy money policy, and six months later, the Chilean peso’s purchasing power has fallen by around 10%. Rent is still priced at 10 UF. But now the peso content of the UF has risen —after all, it takes about 10% more pesos to buy the same consumer basket. The computed rate on the central bank’s website is now 25,000 P/UF. The monthly amount in pesos that the renter must make out to the landlord now comes out to 250,000P (10UF x 25,000 P/UF), up from 23,000. However, while the rent payment is nominally higher, the payment’s UF value is constant. In other words, the transaction represents the same quantity of CPI baskets six months before.

Imagine a 10% peso deflation. The UF sticker price stays constant while the conversion rate to pesos on the central bank’s website falls by 10%. Rent is nominally lower in peso terms, but in representative consumer baskets, it has stayed constant.

The UF/P system is similar to a partially dollarized economy in which the US dollar has been adopted as the unit to price long-term contracts. At the same time, the local currency is used to price current goods and services. Chile differs from partially dollarized economies because the dollar tends to circulate along with the local currency as a medium of exchange. Thus there are two different units-of-account corresponding to two different media of exchange. Chile’s UF, on the other hand, is a purely abstract unit with no corresponding medium.

Contact the Gateway to South America team to learn about the best investment opportunities in the region. The company is a benchmark for foreign investors wishing to invest in Argentina, Brazil, Chile, Paraguay, Peru and Uruguay, providing expert advice on property acquisition and investment tours.

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