DOLLARIZATION

1
DOLLARIZATION

• JUNE 17, 2004
• GROUP 6
• CHRIS BIGGERS
• SCOTT BERMAN
• KRISTY SHANTEAU

2
OVERVIEW

• PRESENTING PRO SIDE OF ARGUMENT
• TOPICS COVERED
• DEFINE TYPES OF DOLLARIZATION
• EFFECTS OF IMPLEMENTATION
• BENEFITS TO BOTH THE U.S. AND THE DOLLARIZED
  COUNTRY
• SPECIFIC CASE STUDIES

3
DEFINITION

• DOLLARIZATION A COUNTRYS EXTENSIVE USE OF THE
  U.S. DOLLAR OR ANOTHER FOREIGN CURRENCY ALONGSIDE
  OR INSTEAD OF THE DOMESTIC CURRENCY.

4
TYPES OF DOLLARIZATION

• THREE CATEGORIES
• UNOFFICIAL DOLLARIZATION
• SEMIOFFICIAL DOLLARIZATION
• OFFICIAL DOLLARIZATION

5
UNOFFICIAL DOLLARIZATION

• DEFINITION -
• Individuals hold foreign currency bank deposits
  or notes (paper money) to protect against high
  inflation in the domestic currency.

6
UNOFFICIAL DOLLARIZATION

• PROS
• PROTECTS AGAINST INFLATION IN THE DOMESTIC
  CURRENCY
• INCREASES THE STABILITY OF THE DOMESTIC BANKING
  SYSTEM
• DEPOSITORS DO NOT HAVE TO SEND MONEY OUT OF THE
  COUNTRY TO EXCHANGE FOR FOREIGN CURRENCY
• SMALLER RISK OF CURRENCY DEVALUATION

7
UNOFFICIAL DOLLARIZATION

• Examples using U.S. Dollar
• Bolivia, Mexico, Israel, Peru, Costa Rica, the
  Caribbean, Armenia, Russia, Ukraine, Mongolia,
  Mozambique, Romania, Turkey and Vietnam to name a
  few

8
SEMIOFFICIAL DOLLARIZATION

• DEFINITION
• Foreign currency used as other legal tender.
• Foreign currency circulates widely but plays
  secondary role to domestic currency.

9
SEMIOFFICIAL DOLLARIZATION

• PROS
• DOLLARIZED COUNTRY RETAINS A DOMESTIC CENTRAL
  BANK
• DOLLARIZED COUNTRY MAY CONDUCT THEIR OWN
  MONETARY POLICY

10
SEMIOFFICIAL DOLLARIZATION

• Examples using U.S. Dollar
• Bahamas, Cambodia, Haiti, Laos, Liberia

11
OFFICIAL DOLLARIZATION

• DEFINITION
• A government adopts foreign currency as the
  predominant or exclusive legal tender.

12
OFFICIAL DOLLARIZATION

• PROS
• DOLLARIZED COUNTRY HAS A UNIFIED CURRENCY WITH
  THE ISSUING COUNTRY
• FOREIGN FINANCIAL INSTITUTIONS CAN ESTABLISH
  BRANCHES, ACCEPT DEPOSITS AND MAKE LOANS, AND
  MOVE FUNDS FREELY INTO AND OUT OF THE COUNTRY
• DOLLARIZATION MAKES A COUNTRY PART OF A LARGE
  POOL OF FUNDS

13
OFFICIAL DOLLARIZATION

• PROS
• THE LOCATION OF LOANS NEED NOT BE CLOSELY LINKED
  TO THE LOCATION OF DEPOSITS
• HELPS STABILIZE THE REAL EXCHANGE RATE
• FOREIGN BANKS CAN LEND FUNDS TO DOMESTIC BANKS
  WHEN DOMESTIC BANKS LACK LIQUIDITY
• ACCESS TO FOREIGN FUNDS OFFERS DOLLARIZED COUNTRY
  A SUBSTITUTE FOR THE CENTRAL BANK

14
OFFICIAL DOLLARIZATION

• Examples using U.S. Dollar
• Panama
• Ecuador
• Argentina (On the Fence)

15
WHY USE THE DOLLAR?

• SINCE 1971 (END OF THE GOLD STANDARD)
• RELATIVELY STABLE AS COMPARED TO OTHER CURRENCIES
  
• WIDELY ACCEPTED
• NO YEARS OF INFLATION OVER 20
• LOSS OF VALUE AGAINST THE DOLLAR NO MORE THAN 25
• NO RESTRICTIONS ON BUYING FOREIGN CURRENCY

16
OTHER POSSIBLE CURRENCIES

• EUROPEAN EURO
• JAPANESE YEN
• SOUTH AFRICAN RAND

17
BENEFITS TO U.S.

• SEIGNIORAGE THE REVENUE FROM ISSUING CURRENCY
• CURRENCY RISK - REDUCED RISK OF A CURRENCY
  DEVALUATION OR REVALUATION
• ELIMINATION OF CURRENCY CONVERSION FEES TO
  TOURISTS AND BUSINESSES

18
BENEFITS TO U.S.

• INCREASED DEMAND FOR AMERICAN GOODS
• ECONOMIC GROWTH
• HELP THE DOLLAR TO REMAIN THE PREMIER
  INTERNATIONAL CURRENCY
• REDUCE COMPLAINTS BY AMERICAN PRODUCERS ABOUT
  FOREIGN DUMPING OF GOODS

19
BENEFITS TO DOLLARIZED COUNTRY

• LOWER EXCHANGE COSTS
• ELIMINATES TRANSACTION COSTS
• INCREASED TRADE AND INVESTMENT
• BANKS MAY HOLD LOWER RESERVES

20
BENEFITS TO DOLLARIZED COUNTRY

• LOWER INFLATION RATE
• SECURITY OF PRIVATE PROPERTY
• ENCOURAGES SAVING AND LONG-TERM LENDING
• REDUCES INTEREST RATES
• ELIMINATES THE DOMESTIC GOVERNMENTS POWER TO
  CREATE INFLATION

21
Case Studies - Panama

• Dollarized in 1904
• First fully dollarized country in Latin America
• Decision to dollarize was based on political and
  historical considerations, not economic
• Used both the dollar and the balboa

22
Case Studies - Panama

• Panama is a natural trade route because of the
  geographical location
• The opening of the Colon Free Trade Zone, a tax
  and import duty free facility for business
  operations, confirmed the importance of
  international goods and financial markets in
  Panama in 1948

23
Case Studies Panama

• Financial system adjusted smoothly as limitations
  were placed on the central bank as the lender of
  last resort
• Liberalization of financial system in 1970 led to
  entry of foreign banks
• Led the economy to be financially integrated with
  complete capital mobility and freedom for foreign
  banks to invest excess funds

24
Case Studies - Panama

• Foreign banks performed the lender of last resort
  by increasing their exposure to the domestic
  economy when economic conditions were weak
• Domestic banks established lines of credits with
  foreign banks with branches in Panama to help
  with liquidity problems
• Reduced the cost of borrowing funds
• Promotes investment and growth

25
Case Studies - Panama

• Between 1980 and 1999 Panamas economy had an
  average growth rate of 3.6 which exceeded the
  averages of other Central American countries
• Also had an average inflation rate of 3 which is
  1 less than the average inflation rate in the
  U.S.
• New economy has low and stable inflation rates
  along with solid economic growth

26
Case Studies - Ecuador

• Officially dollarized in September 2000
• Worlds most populous dollarized country

27
Case Study - Ecuador

• Contributions to Ecuadors economic collapse in
  1999
• Devaluation of the sucre in February
• Freeze on bank deposits in March
• Default on external debt payments in September
• Countrys overall political uncertainty and lack
  of policy direction

28
Case Studies - Ecuador

• A new economic program provided
• incentives to private investment in the energy
  sector
• encouraged privatization of state enterprises
• included legislation that makes labor markets
  more flexible

29
Case Studies - Ecuador

• IMF signed an agreement to support economic
  stability and recovery
• This attracted additional funding from other
  multilateral institutions
• A drop in the inflation rate in July and an
  economic recovery in the first quarter 2000
  supported full dollarization stability effect

30
Case Studies - Ecuador

• Provided confidence shock, stability, and
  generally good economic results
• Enhanced the credibility of economic policy

31
Case Studies - Ecuador

• Promotes
• Fiscal discipline
• Efficient financial system
• The adoption of institutional reforms
• Financial and trade integration with
  international markets

32
Case Studies - Argentina

• Long history of unstable monetary policies
• At turn of century, one of 15 richest countries,
  with its GDP per capita only being 40 percent
  lower than the UK, the world leader It was at the
  same level as Canada, now ½ as rich.
• From 1943 to the present, the price level in the
  US has gone up by a factor of 10, In Argentina
  it has gone up by a factor of 1012 (or
  1,000,000,000,000). Most of this inflation
  occurred in 1975, 1982-1985, and 1987-1990

33
Case Studies - Argentina

• When Carlos Menem was first elected President of
  Argentina in 1989, the inflation rate was 78 per
  month.
• In March 1991, Congress went one step short of
  official dollarization by setting a currency
  board and passing the convertibility law,
  allowing the convertibility of the australes (the
  Argentine currency since 1985) into the U.S.
  dollar at a rate of 10,000 australes per
• January 1992, the Peso replaced the australe at a
  rate of 1 peso per 10,000 australes
• 1 10,000 australes 1 peso

34
Case Studies - Argentina

• The Argentine price level quickly stabilized and
  remained stable over time.
• The GDP Improved greatly The growth rate of
  output grew to an annual average of 4.3 between
  1991 and 1998, from -1 between 1980 and 1990.
• There was a growing concern about the devaluation
  of the peso

35
Case Studies - Argentina

• 2 days after Brazil devalued the real on January
  13, 1999, It became known that President Menem
  asked his financial advisor to study the
  feasibility of official dollarization
• October 25, 1999, Fernando de la Rua took over as
  president of Argentina

36
Case Studies - Argentina

• Argentina On the Fence for Official
  Dollarization. They wanted concessions.
• A Share of Seigniorage
• Access to Federal Reserve System to Borrow in
  times of Stress
• Cooperation on Bank Supervision

37
Case Studies - Argentina

• Advantages of Argentina Dollarizing
• Increased monetary security and credibility
• Increased support by Investors because of lower
  threat of devaluation
• Total loss of seigniorage, if unilateral
  dollarization occurs, is minimal, approx. 0.2 of
  GDP or 1.2 of total government revenues. Even
  less is bilateral dollarization with US occurs
• Other countries would see the success and follow

38
Summary

• DOLLARIZATION A COUNTRYS EXTENSIVE USE OF THE
  U.S. DOLLAR OR ANOTHER FOREIGN CURRENCY ALONGSIDE
  OR INSTEAD OF THE DOMESTIC CURRENCY.
• THREE TYPES OF DOLLARIZATION
• UNNOFFICIAL DOLLARIZATION
• SEMIOFFICIAL DOLLARIZATION
• OFFICIAL DOLLARIZATION
• DEVELOPING COUNTRIES WOULD GREATLY BENEFIT FROM
  OFFICIAL DOLLARIZATION
• BOTH PANAMA AND ECUADOR HAVE BENEFITTED FROM
  DOLLARIZATION AND ARGENTINA SHOULD GET OFF THE
  FENCE AND DOLLARIZE

39
REBUTTLE?