Dollarization: Lessons from Europe and the Americas

Dollarization: Lessons from Europe and the Americas

Dollarization: Lessons from Europe and the Americas

Dollarization: Lessons from Europe and the Americas

Synopsis

The dollar is well on its way to becoming the world's currency. With literature on the fascinating subject of dollarization sparse at best, this book is impressive in its timeliness as well as its authority.

Excerpt

Dollarization has emerged in the last few years as a serious policy issue. Two events contributed to its policy relevance. On the one hand, the string of financial crises in the late 1990s in Asia, Russia, and Brazil - and most recently in Argentina - has triggered a revision of the conventional wisdom about the ways emerging market economies deal with the increased worldwide capital mobility. the central issue is one of policy possibilities: faced with a financial crisis, what can a country do? Devaluation is a possibility, although flexible exchange rate solutions have come under increased scrutiny and criticism, especially when applied to emerging economies (Hausmann, 1999). Some sort of fixed exchange rate system becomes, once again, a policy option.

Second, the relative success of the euro (at the time of writing this, the euro has regained much of its decline against the us dollar) has led many to argue in favor of currency blocks. Moreover, Courchene and Harris (1999) have argued that the success of the euro may represent a threat to the hegemonic role of the us dollar as an international reserve currency that American citizens desire to hold. the us should therefore promote dollarization in order to maintain this role.

If dollarization is increasingly a policy issue, we must differentiate between full and partial dollarization. in the latter case, also known as de facto dollarization, local currencies exist and circulate alongside the us dollar. Partial dollarization is fairly widespread, as many countries today have a significant proportion of bank assets or liabilities in us dollars. the us dollar can be used as a means of payment (medium of exchange), in addition to the local currency, which is known as currency substitution (see Calvo, 1996, Chapter 8), or can be used as a store of wealth (asset substitution). Full dollarization, however, is a situation by which countries fully abandon the local currency. Only the us dollar would exist and all assets and liabilities would be denominated in us dollars. in this way, exchange rate risk is eliminated for good, although country risk may remain.

However, de facto or partial dollarization, if irreversible (see Dean, 2000), represents for some a potential problem. For Eichengreen and Hausmann (1999), for instance, the use of a local currency mixed with the inability of that country to

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