Full Dollarization: A Last Resort Solution to Financial Instability in Emerging Countries?

Abstract

This paper will examine the question of official dollarization. To clarify the discussion, a taxonomy of dollarization regimes is drawn up in order to make an inventory of officially dollarized countries, territories and dependencies. The foundations for adopting full dollarization are analysed through three elements: an account of the limits to corner solutions, the identification of the economic contexts which are favourable to the adoption of foreign currencies and the reasons behind the legitimacy crisis of national currencies. To determine what is at stake in such decisions, cost advantage analysis mentions, first of all, the expected benefits highlighted by the advocates of complete dollarization. A detailed study of its potential impact will then allow us to evaluate the induced costs of the disappearance of national currencies. Finally, by looking at emerging countries which have adopted this exchange regime, the limits of adopting such a solution are underlined, particularly by the fact that the disappearance of national currencies implies an abandonment of monetary sovereignty and a loss of a powerful symbol of national identity.

L'objet de cet article est d'alimenter le débat sur la dollarisation officielle. En raison de son coût d'opportunité, le remplacement d'une monnaie nationale par une devise étrangère constitue une solution de dernier ressort à l'instabilité financière des économies émergentes. Pour éclairer la discussion, une typologie des régimes de dollarisation est dressée afin de recenser les pays, territoires et dépendances officiellement dollarisés. Les fondements du changement de régime monétaire sont présentés à partir de trois éléments: l'analyse des limites des corner solutions, l'identification des contextes économiques favorables à l'introduction d'une devise étrangère et les raisons de la crise de légitimité de la monnaie nationale. Pour comprendre les enjeux d'une telle décision, l'étude des avantages-coûts souligne en premier les bénéfices espérés mis en valeur par les partisans de la dollarisation intégrale. L'exposé détaillé de son impact potentiel permet ensuite d'estimer les coûts induits par la substitution monétaire. En prenant pour exemple les pays émergents qui ont choisi cette option monétaire, on précise enfin le terrain d'application limité d'une telle mesure, la disparition de la monnaie domestique entraînant l'abandon d'une souveraineté monétaire et la perte d'un puissant symbole d'identité nationale.

Notes

Associate Professor in Economics at the Institut d'Etudes Politiques de Toulouse (France), researcher at LEREPS-GRES (Laboratoire d'Etude et de Recherche sur l'Economie, les Politiques et les Systèmes Sociaux, Université Toulouse 1 Sciences Sociales) and Director of Postgraduate Studies: ‘Master in European Banking and Finance’ (Université Toulouse 1 Sciences Sociales).

1. See Minda [2001] for the result of the experience of the selective control of the inflow of capital in Chile between 1991 and 1998.

2. During the 1990s, in Latin America, nominal and real interest rates were the lowest in Panama [Bogetić, 2000].

3. Expression used by Keynes with regard to the gold standard.

4. In 2002, exports to the European Union represented 80 per cent of total exports for Tunisia, 73 per cent for Morocco and 65 per cent for Algeria.

5. Despite the preference for complete dollarization in the business community, Mexican authorities do not envisage abandoning the floating regime that was introduced after the 1994 crisis. Arès [2001b] has shown that the question of national identity explains the hesitations of the Canadian federal government: ‘monetary union is interpreted as an unacceptable abdication of Canadian sovereignty for the benefit of the United States’ (pp.41–2).

6. In case of complete dollarization within NAFTA, Bergstein [2000] wonders whether the US should offer Canada and Mexico the possibility to participate in the elaboration of American policy in the FOMC (Federal Open Market Committee).

7. An opinion poll revealed that 73 per cent of the population in Ecuador was against dollarization (The Economist, 19 Feb. 2000).

Additional information

Notes on contributors

Alexandre Minda

Associate Professor in Economics at the Institut d'Etudes Politiques de Toulouse (France), researcher at LEREPS-GRES (Laboratoire d'Etude et de Recherche sur l'Economie, les Politiques et les Systèmes Sociaux, Université Toulouse 1 Sciences Sociales) and Director of Postgraduate Studies: ‘Master in European Banking and Finance’ (Université Toulouse 1 Sciences Sociales).