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Debate: Dollarization

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Should countries change their official currency to the U.S. dollar?

Background and context

Official dollarization involves a country abandoning an independent currency. In dollarized countries, only a foreign currency is legal tender (though local coins may be produced).Countries that normally adopt such a radical change in monetary policy are often encountering instable economies, high levels of inflation and a very low competitive currency. Dollarization usually involves the US dollar, but may increasingly refer to conversion to other currencies such as the Euro.Worldwide, different countries have adopted different foreign currencies like the US dollar, the Euro or the Australian dollar. Panama, Ecuador and El Salvador are all currently "dollarized", as are many small countries including East Timor, and dollarization was seriously suggested as a solution to Argentina’s recent crisis. Dollarization is different from monetary union because the US continues to set monetary policy in its own interest alone, whereas the European Central Bank (for example) is required to take all Eurozone countries’ interests into account.There are 13 euro countries as of January 1st 2007 and they include Belgium, Germany, Greece, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland and from 1 January 2007: Slovenia. Unofficial dollarization is happening is Kosovo and Montenegro that currently use the Euro as a means of payment, replacing the "de facto" currency -the German Mark.Since most often it was mainly small, developing countries that have dollarized, numerous questions about the viability of such an action and its potential positive and negative effects arise.Its effects on the political and economic levels have split the specialists in advocates and opponents of such a policy, making it a contentious subject in international monetary and political studies.

Contents

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Growth: Does dollarization improve economic growth?

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Yes

  • Dollarization has historically improved economic growth Dollarized countries have been able to stabilize their economies and promote economic growth. Better integration into theinternational financial system and higher credibility among foreign investors, all have been effects of the dollarization policy.Cheaper international borrowing has lowered mortgage rates, spurred consumer credit and increased household consumption all leading to higher rates of economic growth.
  • Dollarization increases market access and integration The monetary union in Europe among EU members has shown that giving up domestic currencies and adopting the Euro has enhanced the financial integration among the member countries
  • Dollarization can increase competition, innovation, productivity Dolarization removes arbitrage within trade.Arbitrage is is the practice of taking advantage of a price differential between two or more markets.When this happens entrepreneurs in the dollarized country are faced with a large array of opportunities on how to better perform within international trade.This will make them focus on improving producion skills, developing niche businesses, invent and increase their competitiveness. Empirical examples from El Salvadaor prove this has been the case post dollarization and it has lead to even more economic growth.
  • Dollarization helps "level the playing field".
  • Dollarization can help lower borrowing costs Dollarization provides countries with access to the international financial systems.This competitive environment and the fact that there is no longer a monetary control agency both provide incentives to adopt a responsible borrowing behavior with a focus on repaying debts. This increases the credibility of that country internationally. Consequently they will have easier access to cheaper borrowing once they have restored their credibility as a sovereign borrower.
  • Dollarization makes sense for nations trading mainly with US Dollarization significantly reduces transaction costs and eliminates currency conversion fees. It helps in this way enhance economic links between the dollarized country and the currency issuer country. From the perspective of the dollarized country , dollarization stabilizes their inflation and improves their credibility internationally.Hence they can extend their trade with the currency issuer country and gain more benefits as the transaction costs are lower. From the perspective of the currency issuer country,the elimination of a currency risk leads to more trust from the consumers in any of the dollarized countries' products. Also the elimination of the currency conversion costs can provide incentives for tourists and business to go and invest in the dollarized country.
  • The US often financially supports nations that dollarize. The United States often offers financial incentives to those countries that dollarize. Nations can benefit economically from such financial support from the United States.
  • Dollarization works best for small, interdependent nations The example of Ecuador proves that for a small independent country that was undergoing hyperinflation and a high levels of instability in the financial markets was able thanks to dollarization to stabilize inflation and improve its inetrantiona rankings in terms of financial credibility.
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No

  • Dollarization does not end the risk of default Even when a country dollarizes, the fundamentals of its debt do not change. If it unable to repay its now dollar-denominated debts, it will still have to default.
  • Dollarization will not help nations with sound economic policies Countries with sound and stable economic policies do not really need the stabalizing effects of dollarization.
  • Dollarization is a band-aid approach to poor economic policy Dollarization is frequently considered a solution for countries that have poor economic policies. Yet, this essentially accepts these poor policies, puts a band-aid over them, and shirks the responsibility to improve the fundamentals of a country's monetary policies. Such a band-aid approach is irresponsible, as it denies countries the opportunity to learn from their mistakes and develop sound monetary policies.
  • Dollarization limits monetary policy flexibility It is frequently important for countries to be able to adjust interests rates or the printing of money in order to respond to certain economic conditions, such as recession. But, by dollarizing, a country is forced to follow the monetary policies of the United States Federal Reserve. This puts countries in what is often called a monetary policy "straight jacket", and can make it difficult to respond appropriately to economic conditions and avert such events as recessions.
  • Dollarization places constraints on US monetary policy Particularly as dollarization becomes more widespread, it becomes increasingly important that the United States be vigilant regarding the consequences of its monetary policies for other nations. If a particular US monetary policy adjustment is to have a negative impact on the majority of dollarized nations, for example, it will be more difficult the United States to implement such an adjustment. Such considerations will have a generally constraining impact on US monetary policy.



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Averting crises: Can dollarization help countries avoid financial crisis?

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Yes

  • Dollarization and integration encourage stability Dollarization combined with a financial integration provide the dollarized country with access to the large realm of international funds and liquidity.This means that there can be exchanges of funds between the dollarized country and the currency issuer country without any risk.This reduces the instability of foreign capital flows and also helps stabilize exchange rates. Ultimately, a more stable financial system in the dollarized country benefits consumers that will have access to internationally competitive international financial institutions.
  • Full dollarization can protect countries from currency crises. The Argentine and East Asian crises showed that partially fixed exchange rates expose countries to the risk of sharp falls in the exchange rate when speculators attack. Under dollarization there is no exchange rate to be attacked, so speculators have no role.[2]
  • Dollarization shows commitment to renouncing currency devaluations Dollarization has been proven to eliminate the posibility of currency crises. Thourgh the decision to give up one's ability to conduct monetary policy , the dollarized country has no ability to appreciate or devalue their currency as to have an advantage in international trade. This inability coupled with the stability of the adopted currency mean the dollarized country cannot actually pursue any policy towards currency devaluations.
  • Dollarization can reduce the risk of inflation: Governments, especially in developing countries, are very bad at controlling inflation. They always want to increase short term growth at the expense of long term stability. Governments should tie their own hands through dollarization to make their anti-inflation rhetoric credible.[3]
  • Monetary policy is not that important to maintain in the face of dollarization Countries are just as likely to abuse it and cause high inflation as they are likely to use it correctly. Developing countries never truly have independent monetary policy anyway, their economies are heavily affected by the United States’ policies even without dollarization, since changes in the US interest rate change demand for their exports.[4]
  • Countries currently operating some sort of fixed exchange rate (as many developing countries do) cannot operate as lenders of last resort anyway: A lack of lender of last resort functions can promote a stronger, healthier banking system, and helps prevent the kind of "crony capitalism" that bedevilled South East Asia. Banks cannot take on risky loans, relying on the central bank to bail them out if necessary.[5]


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No

  • Currency crises can be better avoided under floating exchange rates. If the government does not try to fix the exchange rate, then the rate will constantly adjust, with gradual falls instead of sharp crises.[6]
  • Announcing dollarization can cause financial panic The announcement that a country is dollarizing often comes a year in advance of the initiation of the process. This can cause fears of a country's economic instability or pending crisis, and can result in such things as capital flight, in which foreign money is rapidly withdrawn from the country.
  • Overnight dollarization is not feasible While some respond to concerns about financial panic and damage during a long transition period to dollarization with the notion of "overnight dollarization", there are reasons why this cannot be achieved.
  • Dollarization limits monetary policy flexibility It is frequently important for countries to be able to adjust interests rates or the printing of money in order to respond to certain economic conditions, such as recession. But, by dollarizing, a country is forced to follow the monetary policies of the United States Federal Reserve. This puts countries in what is often called a monetary policy "straight jacket", and can make it difficult to respond appropriately to economic conditions and avert such events as recessions.
  • Dollarization places constraints on US monetary policy Particularly as dollarization becomes more widespread, it becomes increasingly important that the United States be vigilant regarding the consequences of its monetary policies for other nations. If a particular US monetary policy adjustment is to have a negative impact on the majority of dollarized nations, for example, it will be more difficult the United States to implement such an adjustment. Such considerations will have a generally constraining impact on US monetary policy.
  • Other methods are available to limit inflationary tendencies: Independent central banks are widely used in the developed world, and can work for developing countries if effort is put in to designing the institutions correctly. It is ridiculous to suggest governments should restrict their own ability to help their economies, just because some governments have sometimes misused this power.[7]


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Sovereignty: Does dollarization uphold sovereignty and democratic practices?

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Yes

  • High inflation and economic instability have historically led to authoritarian regimes In order for money to perform its role it there is a “a priori” need or inflation not to occur. Inflation according to Austrian School Monetarist, Steven Horwitz, distorts monetary calculation and the ability of money to coordinate people . Out of the need for coordination and order people will look to other means or achieving order , more specifically through the political process. His argument is that inflation makes people more likely to desire totalitarian regimes and provides the example of now the inflationary periods of interwar Germany allowed for the rise of National Socialism.
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No

  • Dollarization undermines the sovereign symbolism of a national currency National currencies are often a powerful part of national identity. Replacing them with a symbol of another country's national identity is often an affront to many citizens and their sense of nationalism and sovereignty.
  • Dollarization can violate sovereign democratic control It is concerning that a country would give up control of its sovereign monetary policies to the United States. The main problem is that this jeopardizes the democratic influence of a country's population on monetary policy or democratic election of the leaders that control such policies. Dollarization undermines all of these democratic checks.
  • Dollarization is difficult where anti-Americanism is pervasive Dollarization is a maneuver that sees a significant degree of a country's own image, in its currency, replaced by the image of the United States dollar. In nations where anti-Americanism is high, such a situation is not welcome, could lead to protests and violence, and may have political costs for national leaders that adopt such policies. It may also accentuate anti-Americanism and, subsequently, even terrorism.
  • Dollarization is part of US imperialist interests Dollarization increases the influence and power of the United States and its markets in the world. Moves by the United States to dollarize other countries can be viewed as, in part, a self-interested move to increase the country's economic influence and power. Such economic imperialism should be resisted.
  • It is too difficult for countries to de-dollarize. Changing currencies is a painstaking process for a country. It is no different when de-dollarizing. But, there are some additional constraints revolving around the effects that such de-dollarization may have on relations with America and even American monetary policy.


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Legal issues: Does dollarization conform appropriately with contracts and the law?

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Yes

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No


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Trade? Does dollarization promote trade?

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Yes

  • Stabilizing the exchange rate against the dollar reduces risks, thus encouraging other countries to engage in trading with that country: This, in turn, promotes economic growth.[8]


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No

  • Dollarized countries will be vulnerable to being outcompeted in export markerts by countries who have retained their own currency, which may well devalue over time relative to the dollar, making their exports relatively cheaper
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Seignorage: Is dollarization's impingement on national seignorage tolerable?

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Yes


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No

  • Dollarized countries lose right to seignorage (print money): Issuing money means gains to the central bank, because you can buy goods with a new note but it does not cost much to produce it. These gains form part of government revenue. They can be significant: 9% of the Brazilian government budget comes from seigniorage. These gains are transferred to the US under dollarization.[10]


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De-dollarization: Is de-dollarization easy enough?

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Yes

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No

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United States: Is dollarization beneficial for the US?

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Yes

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No

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Partial Dollarization vs.Fully Dollarized, a better option?

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Yes

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No

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United Kingdom: Should the United Kingdom dollarize?

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Yes


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No

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Canada: Should the Canadian government dollarize?

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Yes

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No


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Pro/con resources

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Yes

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No


See also

External links

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