|
Dollarization
|
Dollarization means adopting the US dollar
as the currency of choice in a foreign country. Many countries
today
are already dollarized unofficially. Where the purchasing power
of
the local currency has been volatile, as in Latin America and in the
former
Soviet Union, people often hold dollars as a store of value. In
those
cases the domestic currency is commonly used in small transactions, but
the dollar is preferred in large transactions and in savings.
Official Dollarization
In some countries, using the
dollar in transactions
is perfectly legal, in others it is not. In a very few, the US
dollar is the official currency, mostly in small or developing
countries.
Panama has been officially dollarized since 1904. Other countries
have on
occasion
considered moving to an official dollarized system.
Under official dollarization the
local currency
is completely replaced by the dollar, with the possible exception of
coinage.
That means domestic banks only accept dollar checking accounts and
issue
dollar loans. Federal Reserve notes are legal tender and the only
form of paper money recognized by the government.
Before its latest political and
economic crisis,
Argentina operated under a currency board system that
maintained
an exchange rate of 1:1 between the dollar and the peso. That
required
holding sufficient dollar reserves to fully back the pesos in
circulation.
The dollar was recognized as legal tender along with the peso.
Argentina
has since abandoned the peg to the dollar and gone to a floating
exchange
rate for the peso.
In the wake of the Asian and Brazilian economic crisis,
Ecuador was
unable to avoid a deep recession and banking crisis. In March
1999
the government froze deposits in the entire banking system as the value
of the sucre dropped. A year later, after much political turmoil,
and with the help of the IMF in structuring its financial system,
Ecuador
adopted the US dollar as its official currency. This will be an
important
test of dollarization under very difficult conditions.
The US Position
There is nothing to prevent a
country from unilaterally
moving to an official dollarized currency, although the Fed has
recommended
that it be consulted in advance. At the very least, the Fed would
need advance notification of the extra notes that it would have to make
available.
The Fed has stated that under no
conditions would
it act as a lender of last resort to foreign banks, nor would its
monetary
policy be contrary to the best interests of the US. So far, US
officials have taken a neutral position, neither encouraging nor
discouraging
dollarization. However there are many issues, pro and con, for
the
US and a dollarizing country that deserve careful
consideration.
Here are a few:
A Stabilizing Factor
A country with its own currency,
typically issued
by a central bank, can exercise its own monetary policy. In
theory
this enables it to manage its money supply, interest rates, and to some
extent the exchange rates solely in its own self-interest. In
practice
however many developing countries have experienced serious problems in
their monetary affairs, lacking the institutions and experience
needed.
It is likely that official dollarization would significantly improve
price
stability in those countries with a history of monetary problems.
Loss of Independent Monetary
Policy
On the other hand dollarization
means that the
country can no longer tailor its monetary policy to suit its own
needs.
Unless its economy closely tracks the US economy, that can be a
serious
limitation at times. Nevertheless the discipline required might
be
worth the loss of flexibility. The added stability should offer a
better environment for planning business expansion and new
enterprise.
Under dollarization the central bank would no longer be able to create
money, but it would still retain the important task of administering
banking system regulations and ensuring sound banking practices.
Seigniorage Effects
The US gains added seigniorage
benefits as countries
increase the use of dollar currency. The annual cost to the US
of creating and servicing its currency is now less than 0.1% of the
face
value of currency outstanding. The notes however are sold at face
value. Thus notes that are purchased for use overseas are the
equivalent
of nearly cost-free imports of goods and services to the US.
If the US wished to encourage
certain countries
to officially dollarize their economies, it could easily afford to
share
some of the seigniorage benefits. That seems a reasonable
tradeoff,
since dollarization would enhance trade with those countries, to the
advantage
of both.
Political Considerations
An important political issue is
the effect on
national pride. Most people see their currency as a symbol of
national
sovereignty. Losing their own currency could be difficult for
many
to accept. It could foster the 'imperialist Yankee' reaction,
particularly
when some incident strains relations. Also their politicians
could
find it convenient to lay the blame for their own mismanagement and
poor
economic conditions on US monetary policy. These, rather than
purely
monetary issues, appear to be of primary concern to the US.
.
Next
Article Home
|