Viewpoint: Dollarization: Don't Bother

Adopting the greenback is no panacea. It could even make things worse.
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No intellectual fashion comes without its cant. The growing clamor for replacing Latin American currencies with the dollar, however, is unusually loaded with bad history, the creation of straw men and narrow thinking.

The debate over dollarization has polarized academia and business. It has been addressed by the most powerful policymakers, including

Federal Reserve

Chairman

Alan Greenspan

and

Treasury

Secretary

Robert Rubin

. It pits noted pro-dollarization scholars, including Steve Hanke of

Johns Hopkins University

and Robert Barro of

Harvard

, against skeptics like

Massachusetts Institute of Technology

economist Paul Krugman and credit rating agency

Moody's Investors Service

.

Dollarization's fans are on a roll, and their idea is being favorably received in many quarters. But a closer look reveals that it is too simplistic to believe that the adoption of the U.S. dollar will serve as a panacea for Latin America's ills. Its proponents' arguments are full of holes.

Typical, in both tone and substance, of recent pro-dollarization polemics is an article by Judy Shelton, a board member of

Empower America

, a conservative think tank, who chided Secretary Rubin in the op-ed pages of the April 29

Wall Street Journal

for not supporting the move. "Instead of embracing those nations that no longer wish to manipulate their money for short-term political gain at the expense of long-term prosperity, U.S. leaders spurn them with warnings about losing their 'monetary policy independence,'" she wrote, quoting from an April 21 speech by Rubin.

The message here is that Latin American countries without fixed-exchange rates are incapable of running sensible economic policies. Instead, Shelton implies leaders of such countries only care about manipulating monetary policy to win elections. And to permanently keep them from pump-priming, they have to hand monetary policy over to the

Yanquis

.

In actuality, Latin American policymakers have behaved responsibly since the 1994 Mexican devaluation crisis. Throughout the recent emerging-markets crisis, Mexico, with a floating currency, and Chile, with a highly flexible peg, kept a steady hand on the tiller. And who can forget Brazil

President Fernando Henrique Cardoso

campaigning in last year's elections even as the central bank was jacking up interest rates to sky-high levels and sending the economy into recession? Yes, Brazil devalued soon after, but even as Cardoso's poll ratings are sinking to all-time lows, he has not forced the central bank to open the monetary floodgates.

Tellingly, Shelton quotes selectively from Rubin's speech. His preceding sentence reads: "No exchange rate, fixed or floating, can remain stable unless it is backed by sound policies." That's the sort of common sense that doesn't penetrate the minds of ideologues. A healthy economy and good policies will do much to lessen the chance of excessive currency depreciation or devaluation. By contrast, Argentina's fixed currency is creating for the country huge fiscal problems that politicians have no desire to tackle, as displayed by

Congress'

rejection again this week of steep budget cuts.

Moreover, Panama, a long-dollarized country, has failed to show economic growth this decade that gets anywhere close to, say, Chile. And one can help wondering why dollarization advocates don't bring up Liberia, the only other fully dollarized country in the world.

Clearly, prosperity and stability have their roots in an array of policies and conditions. To expect a fixed currency to instill discipline in an economy is like a weightlifter thinking that all he has to do to improve performance is tighten his weight-belt.

In addition, many pundits do not think dollarization would be that big a deal. Moody's, in a March report, concluded that dollarization in Argentina "would not have a significant impact on the credit quality of the country." Recent history even seems to favor floating currencies. Many pundits predicted disaster for the U.K. after the pound came out of the

European Exchange Rate Mechanism

in 1992. But since then, the country's economy has kept up with and even outperformed its fellow

European Union

members. And the U.S.' current prosperity has happened with a floating greenback.

Finally, let's not forget that Latin countries tried a variation of dollarization before. Michael Pettis, a

Bear Stearns

banker and

Columbia University

academic, points out that in the late 19th and early 20th centuries, Argentina backed its currency and government bonds with gold (analogous to dollars today), but was forced to jettison this practice when developed countries tightened monetary policy.

It didn't work then, and it won't now.

Do you think dollarization might help to prevent future currency crises?

Yes

No

Do you think allowing other countries to use the dollar as their currency poses risks to the U.S.?

Yes

No

Would other currency regimes be more effective in promoting more stable currency values, particularly in the emerging markets?

Yes, currency boards seem to be a good compromise between floating currencies and dollarization.

Yes, "crawling pegs" work to aim a currency toward its long-term equilibrium value.

Yes, despite all the problems, I still think fixed exchange rates are the best.

Yes, there is no long-term alternative to freely floating currencies.

No, dollarization seems to offer the most promise.