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Debate: Dollarization

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

This article is based on a Debatabase entry written by Sarah Monroe. Because this document can be modified by any registered user of this site, its contents should be cited with care.

Contents

Background and Context of Debate:

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). Dollarization usually involves the US dollar, but may increasingly refer to conversion to other currencies such as the Euro. 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.

Avoiding financial crises: Can dollarization help countries avoid financial crisis?

Yes

Argument: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.[1]

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.[2]

Fighting Inflation: Does dollarization decrease the risk of inflation?

Yes

Dollarization reduces 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]

Lowered inflation risks encourages investment: The fear of high inflation is a major factor inhibiting investment in developing countries. By dollarizing, these fears can be settled, and investments are likely to flow more freely.[4]

No

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.[5]

Monetary policy: Does dollarization, and the sacrifice of a country's independent monetary policies, have significant consequences?

Yes

Monetary policy is not actually very useful: 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.[6]

No

By losing the ability to set interest rates, governments lose the ability to help their country in a recession: When times are bad, they are unable to devalue their currency in order to increase demand and encourage recovery. Monetary policy is a key tool for managing your economy, and giving it up exposes countries to economic slumps that cannot be corrected. And, unlike in a currency union, the US sets monetary policy for its currency with complete disregard for the interests of dollarized countries, opening the potential that the exact wrong measures will be taken for a dollarized country in recession.[7]

Seignorage: Can dollarized countries compensate (or be compensated) for the loss of "seigniorage"?

Yes

It is likely that the US will eventually share the benefits of seigniorage: An International Monetary Stability Act proposing this has been debated in the US and although not passed, is still an issue of strong debate. Some future compromise is likely. In any case, the benefits of seignorage are small compared to the benefits of dollarization.[8]

No

Dollarized countries lose "Seigniorage benefits": 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.[9]

Promoting trade? Does dollarization promote more international trading for a country, and is this a good thing?

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.[10]

No

Further trade integration with the United States may not be a good thing: Countries will become dependent on the good-will of US trade policies. This is not worth the sacrifices.

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

Lender of last resort: Is the loss of the ability to act as a "lender of last resort" ok for dollarized countries?

Yes

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.[11]


No

Without an independent central bank, countries have no "lender of last resort" to rescue banks if there is a banking crisis. This means people will have less faith in the banking system, and that any banking crisis will be disastrous.[12]

References:

Motions:

  • This House would dollarize.
  • This House prefers the greenback.
  • This House believes a national currency is not worth it.
  • This House believes it is time South America accepted the dollar.
  • This House believes the government can’t be trusted to run the economy.

In legislation, policy, and the real world:

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External links and resources:

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