Academic journal article Journal of International Business Research

Is the Dollarization of Mexico Warranted?

Academic journal article Journal of International Business Research

Is the Dollarization of Mexico Warranted?

Article excerpt

ABSTRACT

The adoption of the dollar as the primary currency by a country is termed dollarization. This paper examines some of the general qualities that make a country a candidate for dollarization. Some of these qualities include being a part of an optimum currency area, having high inflation and devaluation, and having unstable prices. This paper then goes on to specifically evaluate Mexico as a candidate, and the related factors associated with dollarizing

Mexico. It was found that theoretically Mexico is an excellent candidate for dollarization. However, due to complicated political and social factors and the lack of long-term evidence in other countries, dollarization is not yet warranted for Mexico.

INTRODUCTION

There has been a great debate regarding the implications of countries adopting the U.S. dollar as their currency. Under dollarization, a country would give up its control over its money supply and its ability to conduct an independent monetary policy. In exchange, the country would enjoy the stability and credibility of the dollar (Salvatore, 2001). Dollarization, like any economic and financial change, has its benefits and costs which are country-specific. The implications of dollarization are extremely complex. Each country that evaluates dollarization will be faced with a vast array of challenges. Mexico has had a very volatile past in regards to its monetary position. Recurrent devaluation has plagued Mexico's peso for the past three decades (Garza, 1999). This in turn has been accompanied by severe price instability. Mexican leaders are currently seeking a solution to this problem. Dollarization is a possible solution, but it may lead to other social, political, and economic complications. This paper will address the criteria for dollarization, and its general implications. Then it will address Mexico fit for dollarization. Next, the position of the stakeholders will be addressed. Estimated benefits and costs associated with Mexico's dollarization will be addressed. Next, opposing viewpoints of Mexico's dollarization will be discussed. Finally, a conclusion will be made as to whether dollarization is recommended for Mexico.

LITERATURE REVIEW

The term dollarization refers to using U.S. dollars instead of domestic currency as a unit of account, store of value, or medium of exchange (Melvin & Peiers, 1996). It can also be viewed as the most extreme form of a fixed exchange rate (Velde & Veracierto, 2000). In its most basic form, dollarization occurs when a country willingly replaces its own currency with that of the U.S. dollar. In the case of Argentina, which has proposed to implement a full dollarization regime, it eliminates of the Argentina peso and adopts the U.S. dollar in all day-to-day Argentine transactions (Spiegel, 1999). Not only is the currency replaced, the adopting country must also relinquish its control over its own monetary policy and eliminate primary functions of its central bank. Lastly, it can no longer print its own currency and cannot function as a lender of last resort.

The various forms of dollarization can be explained by the following three general categories obtained from the U.S. Senate Joint Economic Committee, 2000 (Hansen, 2000):

1.   Unofficial Dollarization which generally means that at least 30%
     of a country's money supply is in U.S. dollars. These countries
     include most of Latin American and the Caribbean, especially
     Argentina, Bolivia, Mexico, Peru and Central America; most of
     the former Soviet Union; and various other countries including
     Mongolia, Romania, Turkey, and Vietnam.
2.   Semiofficial Dollarization, countries identified by the
     International Monetary Fund (IMF) who are using U.S. dollars as
     another legal tender in addition to their own domestic currency.
     In these countries, the U.S. dollar is widely circulated but
     plays a secondary legal role to the home currency. … 
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