Encouraging Official
Dollarization
in Emerging Markets
April
1999
Joint Economic Committee Staff Report
Office of the Chairman, Senator Connie
Mack
This staff report reflects the
views of the author only. These views do not necessarily reflect those of the
Joint Economic Committee, its Chairman, Vice Chairman, or any of its
Members.
|
SUMMARY In many countries that have suffered high inflation and currency
devaluations, the U.S. dollar is in widespread circulation as an
unofficial currency. People trust the dollar because its long-term record
has been among the best in the world. However, few foreign governments
have been willing to officially dollarize, that is, replace their
domestic currencies with the dollar. One reason is that under current
arrangements, if they do so they lose seigniorage--the revenue gained from
issuing currency. This study explores the implications of the United States offering to
share seigniorage with countries that officially dollarize and meet
certain other requirements. It describes what official dollarization is,
how it works, an idea for sharing the seigniorage from the dollar with
officially dollarized countries, and the effects of dollarization both on
the United States and on dollarized countries. The study concludes that official dollarization has important benefits for the United States and dollarizing countries alike. Dollarization nearly eliminate the risk of devaluation, making domestic and U.S. investment more secure. In most emerging market countries, official dollarization will also reduce interest rates significantly, boosting their economic growth. Higher growth in other countries ultimately means greater demand for American goods and higher growth in the United States as well. People in many emerging market countries have already voted with their wallets for the dollar. By sharing seigniorage with governments that officially dollarize, the United States will promote growth and financial stability both at home and abroad. |
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In the long term, finding ways of bribing people to dollarize, or at least give back the extra currency that is earned when dollarization takes place, ought to be an international priority. For the world as a whole, the advantage of dollarization seems clear to me... Larry Summers (1992)
1. A MISSING PIECE IN INTERNATIONAL FINANCIAL REFORM
The Asian currency crisis and its repercussions in Russia and Brazil over the
last two years have created fresh interest in reforming the "international
financial architecture" in the hope of making it less prone to trouble.
Proposals for reform range from cautious changes in bank supervision to sweeping
recommendations for establishing a global central bank. A recent scorecard
counts no fewer than 16 proposals (Eichengreen 1999, pp. 124-32).
The proposals have three major drawbacks. First, all require international
agreement, which is worthwhile but may take a long time to achieve and
implement. Improving bank supervision internationally, for example, requires
regulators from various countries to resolve some knotty technical issues about
national differences in accounting and legal standards. After regulators reach
agreement, fully implementing new standards of supervision can take several
years. Reforms that are still more controversial, such as managing the
international monetary system through exchange-rate target zones or a global
central bank, face political obstacles that seem insurmountable at present,
quite apart from their flaws in design.
Second, few of the proposals are well specified, so it is hard to judge
whether they are workable. The complex proposals need to have their complexities
visible before implementation, so that weak spots can be detected and fixed. To
mention one proposal, making an international bankruptcy court effective will
involve developing an extensive code of law to apply to bankruptcy
cases--something that has taken decades at the national level.
Third, most proposals neglect that the Asian crisis has been foremost a
currency crisis; the banking, stock market, and budget crises that some
countries have suffered have resulted from the currency crisis rather than
causing it. Proposals that omit currency reform will not solve the problem. As
Table 1 shows, good currencies are rare; the U.S. dollar is one of only a
handful in the world.
The countries that have suffered most from the Asian crisis have been
developing countries with central banks maintaining pegged exchange rates to the
U.S. dollar. Under a pegged exchange rate, a country promises to maintain a
determinate value for its currency in terms of a foreign currency, but retains
features of monetary policy that give it the freedom to devalue at any time and
make eventual devaluation likely. Pegging and target zones, a related
arrangement, are one of three basic options in exchange rate policy. Another is
a floating exchange rate, like the United States, under which a country does not
maintain the value of its currency constant in terms of any foreign currency.
But though the United States has had relatively low average inflation under a
floating exchange rate, most developing countries that have tried floating rates
have not. Those that have pegged their exchange rates have done so mainly as a
way of restraining the inflation they fear would happen under floating rates.
Ruling out pegging and floating leaves the third and best option for developing
countries: a truly fixed exchange rate, which unlike a pegged rate has features
that prevent devaluation.
What is needed, then, is a policy that can be implemented without
time-consuming multilateral agreement, is well specified, and can prevent future
currency crises by offering developing countries a way of achieving a truly
fixed exchange rate. An option that combines all of these characteristics is
official dollarization, under which countries that wish to do so replace
their domestic currencies with the U.S. dollar. Under official dollarization,
the Argentine peso, for example, will cease to exist, except perhaps as coins.
All peso notes (paper money) and perhaps coins will be converted into dollar
notes; all peso assets, liabilities, and prices will become dollar assets,
liabilities, and prices. Since the current exchange rate is 1 peso = 1 dollar, a
bank deposit of 1000 pesos will become a bank deposit of 1000 dollars.
Many countries today are already unofficially dollarized. Throughout Latin
America and in most of the former Soviet Union, people have significant dollar
bank deposits domestically or abroad, hold dollar notes, and quote prices for
high-value items in dollars. In some countries, using the dollar is perfectly
legal, in others illegal, but whatever the case, the dollar is a highly prized
currency. In many countries, officially dollarizing would simply complete the
extensive unofficial dollarization that already exists.
A disadvantage for countries thinking about official dollarization (all of
which so far are emerging market economies) is that under current arrangements,
if they dollarize they lose to the United States all their seigniorage--the
revenue they gain from issuing currency. Seigniorage is the difference between
the cost of putting currency into circulation and the value of the goods the
currency will buy. For example, a $1 bill costs about 3 cents to print, but the
government can use it to buy $1 worth of goods. The seigniorage is 97 cents. For
the U.S. government, seigniorage from issuing dollars is roughly $25 billion a
year, which is a large amount in dollar terms, but less than 1.5 percent of
total government revenue and only about 0.3 percent of gross domestic product
(GDP).
This study explores the possibility that the United States offer to share
seigniorage with officially dollarized countries, as a way of reducing or
eliminating the loss of seigniorage that they would otherwise experience. Their
participation will be voluntary: they can continue to issue their own
currencies, dollarize and share in the seigniorage that the United States earns
if they meet certain criteria, or even dollarize unilaterally without sharing
seigniorage. Under the arrangement described here, dollarization will probably
cost American taxpayers little or nothing initially, will probably generate
increased seigniorage for the United States in later years, and will have
benefits for trade and for financial markets.
Whether countries share seigniorage with the United States or not,
dollarization is complementary to proposals that the U.S. government has made,
both alone and as part of international groups such as the Group of 22 nations
(G-22 1998). It apparently is also complementary to all other proposals for
reforming the international financial architecture. It does not make any other
proposed reforms more technically difficult; in fact, it would make many easier.
Dollarization is in that sense a key missing piece in reforming the
international financial architecture.
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Table 1. Performance of the Dollar Versus Other Currencies, 1971 to 1998 Countries that avoided any years of 20+ percent inflation:
Australia, Austria, Bahamas, Belgium, Belize, Bhutan, Botswana, Canada,
Cyprus, Denmark, some members of Eastern Caribbean dollar zone (Antigua
and Barbuda, St. Kitts and Nevis, St. Vincent and Grenadines), Finland,
France, Germany, Hong Kong, Japan, Jordan, Kuwait,
Luxembourg, Malaysia, Malta, Mauritania, Mauritius, Morocco, Nepal,
Netherlands, Netherlands Antilles, New Zealand, Norway,
Panama, Solomon Islands, South Africa, Sri Lanka, Sweden,
Switzerland, Thailand, Tunisia, United Kingdom, United
States. Countries whose currencies lost no more than 25 percent of their
value against the dollar or did better: Austria, Bahamas, Bahrain,
Barbados, Belgium, Bermuda, Bosnia, Brunei, Cayman Islands, Denmark,
Estonia, France, Germany, Hong Kong, Japan, Kuwait, Latvia,
Libya, Luxembourg, Macau, Malaysia, Netherlands, Netherlands
Antilles, Norway, Oman, Panama, Qatar, Saudi Arabia, Singapore,
Slovakia, Switzerland, Taiwan, United Arab Emirates, United
States. Countries that had no restrictions on buying foreign currency at any time during the period: Bahrain, Germany, Kuwait, Netherlands, Oman, Panama, Qatar, Saudi Arabia, Switzerland, United Arab Emirates, United States. |
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Sources: IMF, Exchange Arrangements and Exchange Restrictions, various issues (series title varies) and International Financial Statistics, various issues. Notes: Bold indicates countries whose currencies satisfy all these criteria, as the U.S. dollar does. The data start at the beginning of 1971 because that was the first year in which the current system of generalized floating among the major currencies started to emerge. For currencies that did not exist throughout the period, the comparison starts with the first year they existed. The data are for members of the International Monetary Fund, which include almost all independent countries but few dependent territories. Information for some countries is incomplete. |
2. BASICS OF DOLLARIZATION
What dollarization is: Dollarization happens when the U.S. dollar to
some extent displaces domestic currency as the preferred currency for holding
savings, making payments, and pricing goods. Often "dollarization" is used in a
generic sense to refer to any foreign currency, not just the dollar, that
displaces domestic currency.
Dollarization can be official or unofficial. Under unofficial dollarization,
typically the domestic currency dominates small transactions but the dollar is
important in large transactions and as a vehicle for savings. Where people do
not trust the domestic banking system, they may also have large bank deposits
abroad in dollars and may hold dollar notes as "mattress money." These are forms
of savings that do not appear in official statistics of unofficially dollarized
countries because the savings are outside the domestic financial system and in
some cases violate national laws against holding foreign currency.
Less widespread is official dollarization, in which a country has no
domestically issued notes and perhaps coins, instead using the dollar as
official domestic currency. Many countries have used foreign currencies at some
point in their history: in the United States, foreign coins were legal tender
until 1857. (At the time, Americans predominantly used coins rather than notes
in retail trade.)
Because this study is specifically about officially replacing the domestic
currency with the U.S. dollar rather than any other currency, "dollarization"
will not refer to unofficial dollarization or to currencies other than the
dollar unless specifically mentioned.
Where dollarization exists: Unofficial use of foreign currency is
widespread. A study from the International Monetary Fund reports that in 1995,
foreign-currency deposits exceeded 30 percent of "broad money" in 18 countries.
(Broad money--M2, M3, M4--is currency plus bank deposits, plus certificates of
deposits and other bank liabilities in some cases.) In another 34 countries,
foreign-currency deposits were lower but still judged significant, averaging 16
percent of broad money (Baliņo and others 1999, pp. 2-3). In most of the cases
of the IMF study, the dollar is the main foreign currency that people hold. A
study by the Federal Reserve System estimates that foreigners hold 55 to 70
percent of dollar notes in circulation, mainly as $100 bills (Porter and Judson
1996, p. 899), though other researchers have estimated higher and lower figures
(Feige 1997; Rogoff 1996, p. 268). Since dollar notes in circulation are
currently about $480 billion, if the Federal Reserve's estimate is correct,
foreigners hold roughly $300 billion. The highest concentrations occur in Latin
America and the former Soviet Union. In Bolivia, for instance, people are paid
in bolivianos and use them for buying groceries and other small transactions,
but about 80 percent of bank deposits and many bank loans are in dollars, and
expensive goods such as automobiles may be priced in and paid for in dollars.
Russians are estimated to hold as much as $40 billion in dollar notes, which is
more than the value of all ruble notes and deposits (Melloan 1998).
The best-known officially dollarized country today is Panama, which
has been dollarized since 1904. Appendix A describes its experience. Panama
issues its own coins and has its own unit of account, the balboa, but since one
balboa equals one U.S. dollar and coins are a small, subsidiary part of the
money supply, that does not interfere with dollarization. Besides Panama, 11
other economies officially use the U.S. dollar; Table 2 lists them. Five are
U.S. possessions. Another 20 or so small economies officially use foreign
currencies other than the U.S. dollar, such as the Australian dollar and French
franc. Several others issue domestic notes and coins but also grant the U.S.
dollar or another foreign currency status as a parallel legal tender. Among them
is Liberia, which formerly used U.S. dollar notes exclusively, but now also uses
the notes of two rival governments issued during the civil war of 1989 to 1996.
Liberian dollars circulate alongside the U.S. dollar at depreciated exchange
rates (Bogeti and Schuler 1999).
Official use of the dollar or other foreign currencies is rare today except
in small economies mainly because of the perceived economic advantages of an
independent monetary policy. An independent monetary policy implies that a
country has a distinct domestic currency, typically issued by a domestic central
bank. According to some economic theories, an independent monetary policy
enables a country to manage the money supply, interest rates, and exchange rates
so as to make economic growth higher or at least less variable than it would
otherwise be. In practice, though, developing countries with central banks have
had worse currencies and lower economic growth than those without central banks
(Ghosh and others 1998; Hanke 1999; Hausmann and others 1999; Schuler 1996).
Despite the poor record of central banking in developing countries, it persists
because many people still believe that it should work well in theory and because
it has the political advantage of allowing a government to print money when it
cannot or does not wish to cover its budget deficits by other means (generating
a type of seigniorage). Finally, many governments see a domestically issued
currency as a symbol of national identity and political pride, even if their
citizens would prefer to use dollars exclusively.
How dollarization works: In an officially dollarized economy the money
supply works similarly to the way it works within the United States. Panama, for
example, has much the same relation to the continental United States as Puerto
Rico or Pennsylvania. If people want to accumulate dollars, they spend less; if
they want to get rid of dollars, they spend more. Prices and the money supply
are determined by a combination of local preferences and arbitrage with the rest
of the world. As within the United States, interest rates and price indexes tend
to move up and down in relatively small steps, not in sudden leaps. Inflation
rates can differ between Panama and the United States just as they can between
Philadelphia and Los Angeles, but the use of a common currency, especially if
reinforced by free trade, tends to keep prices of internationally traded goods
close to the levels they have in the United States, putting a ceiling on
inflation. Interest rates tend to be close to U.S. levels, plus a premium for
country risk (political unrest or other factors operating at a national level
that reduce the prospect a loan will be repaid). Because a dollarized system has
no domestically issued currency, except perhaps coins, there is no need for
exchange controls to support the currency and crises in the balance of payments
do not happen (Ingram 1962).
The main difference between a dollarized country such as Panama and the
United States is that Panamanian domestic banks lack access to the Federal
Reserve System as a lender of last resort. The Federal Reserve acts as a lender
of last resort only to U.S. banks, not to banks from other countries. However,
Panamanian banks can borrow in local money markets that are closely linked to
world markets through the presence of U.S. and other foreign banks. The head
offices of those banks can act as sources of emergency funds for their own
branches and for other banks in Panama. It is also possible for a dollarized
country to establish an international line of credit, such as Argentina has
established for its currency board-like system (BCRA 1998). So, a dollarized
system has or can devise substitutes for a central bank as a lender of last
resort.
Seigniorage: Under current arrangements, countries that dollarize lose
to the United States all their seigniorage. Earlier, seigniorage was defined as
the difference between the cost of putting currency into circulation and the
value of the goods the currency will buy--in the case of a $1 bill, about 97
cents. (Like a $1 bill, a $100 bill costs about 3 cents to print, so the
seigniorage for it is an even larger part of its total value.) More generally,
the concept of seigniorage applies not just to currency, but to the entire
monetary base, which comprises currency in circulation (notes and coins outside
banks) plus bank reserves (note and coins held in bank vaults, and deposits of
banks at the at the central bank or such other monetary authority as the country
has).
An equivalent but more complicated way to think of seigniorage is to observe
that currency pays no interest. Somebody who holds $100 in notes and coins could
instead buy a Treasury bond and earn interest on it. By holding notes and coins
rather than the Treasury bond, it is as if he is giving the U.S. government an
interest-free loan. Under this way of thinking, seigniorage is the monetary base
times some measure of the interest rate.
It is important to distinguish between gross and net segniorage. Gross
seigniorage is the amount earned from issuing currency before taking expenses
into account. Net seigniorage is what is left after paying for printing notes,
minting coins, and employing the staff of the Federal Reserve System. Net
seigniorage is the part of seigniorage available for the rest of the government
to spend. In recent years, the cost of printing notes and minting coins has been
around $400 million a year. The cost of operating the Federal Reserve System has
been roughly $2 billion, of which half has been offset by fees that banks pay,
such as charges for using the Federal Reserve's check clearing system.
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Table 2. Officially Dollarized (US$) Economies at the Start of 1999 | ||||
|
Economy |
Population |
GDP ($bn) |
Political status/ other remarks |
Dollarized since |
|
Guam* |
160,000 |
3.0 |
U.S. territory |
1898 |
|
Marshall Islands |
61,000 |
0.1 |
independent |
1944 |
|
Micronesia |
120,000 |
0.2 |
independent |
1944 |
|
Northern Mariana Islands* |
52,000 |
0.5 |
U.S. commonwealth |
1944 |
|
Palau |
17,000 |
0.2 |
independent |
1944 |
|
Panama |
2,700,000 |
8.7 |
independent issues own coins |
1904 |
|
Pitcairn Island |
42 |
0.0 |
British dependency also uses New Zealand dollars |
1800s |
|
Puerto Rico* |
3,800,000 |
33.0 |
U.S. commonwealth |
1899 |
|
Samoa, American* |
60,000 |
0.2 |
U.S. territory |
1899 |
|
Turks and Caicos Islands |
14,000 |
0.1 |
British colony |
1973 |
|
Virgin Islands, U.K. |
18,000 |
0.1 |
British dependency |
1973 |
|
Virgin Islands, U.S.* |
97.000 |
1.2 |
U.S. territory |
1934 |
|
Total |
~7,000,000 |
~47 |
|
|
|
United States |
268,000,000 |
8,100,000 |
independent |
1700s |
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Sources: Statesman's Year-Book 1998-99; CIA 1998; IMF 1998, 1999. Population and GDP (gross domestic product) are for 1997 or latest prior year available. Notes: * As U.S. possessions, these economies already indirectly receive a share of the seigniorage from being officially dollarized. About 20 other economies use foreign currencies other than the U.S. dollar, such as the Australian dollar and French franc, as the official currency. Several others issue domestic notes and coins but grant the U.S. dollar or another foreign currency status as a parallel legal tender. Except for Panama, estimates of GDP are in terms of purchasing power parity, which typically gives higher figures than the alternative method of exchange rate parity. | ||||
The net earnings of the Federal Reserve include both interest on its holdings
of Treasury securities, which are like seigniorage, and earnings from trading
activity to support its goals in monetary policy. The Federal Reserve buys and
sells Treasury securities and foreign currencies. When its trading activity
generates a profit, its payments to the Treasury are higher than the earnings
from seigniorage alone would be; when trading generates a loss, the payments are
lower. In 1998, more than 90 percent of the money that the Federal Reserve paid
to the Treasury came from interest on Federal Reserve holdings of Treasury
securities. Table 3 shows payments to the Treasury and other statistics relevant
to seigniorage. Recently the payments have been about $25 billion a year. The
great bulk of seigniorage derives from notes; seigniorage on coins was only
about $600 million in 1998 (United States 1999, p. 261).
3. SHARING SEIGNIORAGE FROM THE DOLLAR
People have occasionally suggested before that the United States share the
seigniorage from dollarization, but nobody has described in detail how to do so.
To show what factors need to be taken into account, this study offers quite
specific ideas, though an implemented version may differ in some details.
The idea: The U.S. government will make a standing offer to all
qualifying countries. There will no time limit: qualifying countries can join,
or quit, at any time. A later section describes the criteria for gaining
certification from the U.S. government as a qualifying country. The purpose of
the criteria is to be reasonably sure that dollar notes (paper money), rather
than the notes of some other currency, will predominate in countries that
eliminate their domestic currencies. The United States will accept countries
that wish to accept the offer and meet the criteria for certification, but it
will not pressure any country to use the dollar.
To qualify for a share of the seigniorage from dollarization, then, a country
will have to retire from circulation the entire domestic-currency monetary base,
except for coins if it intends to continue issuing them (like Panama). In most
countries the value of coins in circulation is 5 percent or less of the value of
notes in circulation, so the amount of seigniorage from coins is correspondingly
small.
Economies that are already dollarized but are not U.S. possessions, and
therefore do not indirectly receive a share of seigniorage through Federal
spending, could qualify for a share by temporarily introducing their own
currencies and then re-dollarizing. To avoid such charades, it seems fair to
share seigniorage with already dollarized economies along the same lines as with
newly dollarizing countries. As Table 2 shows, the combined population and
economic size of already dollarized economies that are not U.S. possessions is
quite small, so sharing seigniorage with them will be a correspondingly small
expense.
To prevent any misunderstanding, the terms of the standing offer will state
that countries accepting it acknowledge that the Federal Reserve System will not
act as a lender of last resort to them, nor will it be obliged to take any but
purely domestic considerations into account in formulating monetary policy. That
does not mean that the Federal Reserve will ignore conditions in other
countries: after all, in its recent policy making it has considered the possible
effect on the U.S. economy of currency crises in Asia, Russia, and
Brazil--places that are not even dollarized. Furthermore, the Federal Reserve's
occasional interventions in the foreign-exchange market show that it cares about
the exchange rate of the dollar with other currencies, especially the euro and
the yen. But countries that become dollarized need to understand from the start
that the standing offer applies only to sharing seigniorage. The Federal Reserve
will not be a multinational central bank like the European Central Bank.
To strengthen the Federal Reserve System from political pressure arising from
more widespread official use of the dollar, Congress should revise statute law
to give the Federal Reserve a clearer mandate. The Humphrey-Hawkins Act should
be revised and price stability should be made the sole goal of the Federal
Reserve System. A proposal to accomplish just that was Senator Connie Mack's
Economic Growth and Price Stability Act of 1997 (105th Congress,
Senate bill S. 611), which should be reintroduced. A similar bill in the House
of Representatives was H.R. 2360 of 1997, sponsored by Representative Jim
Saxton.
What should be the basis for calculating shares of seigniorage? The
most logical choice as the basis for calculating shares of seigniorage seems to
be the dollar value of currency in circulation. Another possibility is the
monetary base, which, to repeat, is currency in circulation plus bank reserves.
Many countries require banks to hold a minimum ratio of reserves to deposits; in
the United States the ratio is 10 percent. The part of the monetary base
composed of bank reserves is mainly required reserves, which act as a type of
tax on banks because they are typically higher than banks' economic need for
reserves. Currency in circulation, on the other hand, exists because the public
has a genuine demand for it, not because the public is required to hold a
minimum ratio of notes and coins to total income. Counting the entire monetary
base for calculating shares of seigniorage would in effect reward countries,
such as Chile, that tax their banks more through reserve requirements. This
study assumes for simplicity that only currency in circulation will count for
calculating shares of seigniorage, but the question deserves further thought.
For the purpose of calculating the amount upon which the United States pays
seigniorage, dollarizing countries will be allowed to count the domestic
currency in circulation that the public actually exchanges with them for
dollars, up to a maximum of all domestic currency in circulation.
To become dollarized, a country need only convert domestic currency in
circulation (or at most the domestic-currency monetary base, M0) into some form
of the dollar monetary base; it need not convert broader measures of the money
supply that include bank deposits, such as M1, M2, and M3; domestic-currency
bank deposits will become dollar bank deposits, not dollar notes.
How much seigniorage should the United States share? It is feasible to
divide the seigniorage from dollarization in any proportion: 75 percent for the
dollarizing country, 25 percent for the United States, 50-50, etc. Dollarization
will be more attractive the more seigniorage the United States gives. This study
assumes that the United States will give dollarizing countries all the net
seigniorage from increases in the dollar monetary base attributable to
their becoming dollarized. The United States will retain all the seigniorage it
collects from the approximately $540 billion of the dollar monetary base
already in circulation, except for a small amount to "grandfather"
already dollarized economies.
It bears repeating that sharing the seigniorage from dollarization with newly
dollarized countries--even up to 100 percent of the seigniorage from converting
domestic currency in circulation into dollars--will not reduce the current level
of seigniorage that the United States receives.(1) To obtain
dollar notes, a country will have to give the Federal Reserve System dollar
assets of equivalent value, such as U.S. Treasury securities. If the country
continued to issue its own currency and held the Treasury securities as foreign
reserves, the U.S. government would pay it interest on the securities. By
sharing seigniorage if the country dollarizes, the U.S. government in effect
pays interest on dollar notes that it otherwise would have paid on Treasury
bills. This switch neither adds nor subtracts from the total interest payments
that the U.S. government makes.
Besides sharing seigniorage from the initial amount of dollars, it also seems
fair to share seigniorage from a general increase in the demand for dollars,
according to procedures discussed later. So, if the dollar monetary base doubles
and the interest rate paid remains the same, a dollarized country will receive
approximately double the amount of seigniorage it received when it first
qualified for the standing offer. This seems fair because presumably dollarized
countries will contribute to the general increase in demand for the dollar
monetary base, so they will deserve to share in the resulting increase in
seigniorage. It is like them reinvesting interest on their holdings of Treasury
securities to buy new Treasury securities. Sharing seigniorage from an increase
in demand for dollars also seems fair because demand for dollars depends partly
on inflation, which the United States controls. As long as inflation remains
low, say in single digits per year, people tend to accumulate more dollar notes
when the purchasing power of the dollar falls, so as to maintain a roughly
constant amount of purchasing power. If the United States did not share the
increase in seigniorage resulting from the reduced purchasing power of the
dollar, it would in effect benefit from higher inflation at the expense of other
countries, ultimately reducing towards zero the real value of the seigniorage
they receive and the incentive for them to remain dollarized. Under the formula
listed later, all qualifying officially dollarized countries will share
proportionally with the United States when the dollar monetary base expands or
shrinks.
Sharing seigniorage is important not so much in itself as for reducing an
obstacle to dollarization. Dollarization has the potential to boost economic
growth in many countries because it nearly eliminates the risk of devaluation
and bring interest rates closer to the levels that exist in the United States.
The gains that higher economic growth would generate are potentially much larger
than the amounts involved in seigniorage.
Issues for a dollarizing country: A country that wants to become
officially dollarized will need to consider a number of issues. Among them are:
Whether to continue issuing coins, like Panama, or simply use U.S. coins, like Micronesia.
Whether the existing foreign reserves of the central bank are adequate for dollarization.
If reserves are inadequate, how to obtain additional reserves--by selling domestic assets of the central bank or government, borrowing, etc. As is discussed later, the actual foreign reserves of many countries considering dollarization exceed their official foreign reserves because people hold foreign assets not recorded in official statistics, and a credible monetary reform such as dollarization can being some of these unrecorded reserves into official coffers.
If the United States allows the monetary base beyond currency in circulation to be used for calculating shares of seigniorage, whether the government should convert that part of the monetary base into the dollar monetary base, convert some of it into bonds, or simply write it off.
What exchange rate to use for exchanging domestic currency into dollars. (The more units of local currency per dollar, the lower dollar reserves need to be for immediate dollarization.)
How fast dollarization should proceed. (Immediate dollarization, while technically feasible, may not always be viewed as politically most expedient.)
How to handle the legal aspects of changing currencies; for example, whether to revise contracts for high rates of interest, which were made under the assumption that they would be repaid in a domestically issued currency with higher inflation than the dollar.
How to reorganize the components of the central bank, since dollarization
will transfer to the Federal Reserve System the function of making monetary
policy.
Such issues can be complicated, but it is not necessary to discuss them here
because they do not directly concern the United States and are to some extent
treated elsewhere (Schuler 1999). Under the standing offer, each country that
wishes to share seigniorage from dollarization will be free to take the route to
dollarization that it thinks best so long as it ends up meeting the criteria
that the U.S. government has established for sharing seigniorage. The U.S.
government will have no role except to assure itself that after the conversion
is complete, domestic-currency notes (and coins, if the dollarizing country
chooses) are no longer circulating.
How a dollarizing country will obtain dollars: To obtain dollar notes
and coins from the Federal Reserve System, a dollarizing country will give to
the Federal Reserve highly liquid dollar assets of equivalent value from a short
list specified by the U.S. government--deposits at the Federal Reserve, U.S.
Treasury securities, or funds at U.S. banks. (The gold that many countries keep
on deposit at the Federal Reserve Bank of New York could also be part of the
list, although this is a question that requires further thought.) The dollar
assets can be given to the Federal Reserve directly or though the intermediary
of a bank that specializes in handling dollar notes. The Federal Reserve will
only give dollars in exchange for specified dollar assets; it will not simply
give dollars away. So, dollarization according to this arrangement requires that
a country have 100 percent backing in dollar assets for whatever it dollarizes.
Dollarization does not require that a government already have all the necessary
assets in dollars before it can even consider starting to dollarize. The
government and the central bank can have assets in other currencies, provided
they can readily trade them for dollar notes or for assets acceptable to the
Federal Reserve. In some countries, domestic-currency assets may have a
sufficiently liquid market that the central bank can obtain a substantial amount
of dollars by selling them. Again, the U.S. government will have no role in
deciding what route a country takes to dollarization; all it will do is certify
that a country qualifies for sharing seigniorage.
The dollarizing country will agree with the United States on a date for
becoming officially dollarized, which will become the date on which the United
States begins crediting to that country a share of seigniorage. By that day, at
least 75 percent of domestic currency in circulation must have been exchanged
for dollars. From that day on, no new domestic-currency notes and (if
applicable) coins will be manufactured or placed into circulation, and the
plates and dies used to make them will be destroyed. A threshold of 75 percent
seems advisable because it is unrealistic to expect that people will redeem 100
percent of the domestic currency in circulation for dollars. Some notes will be
kept by collectors, or will have been lost or destroyed. Substantial rather than
total replacement of the monetary base should be the standard for determining
that a country is dollarized.
Especially in large dollarizing countries, governments will probably find it
desirable to allow people to continue to exchange domestic currency in
circulation for dollars for some time after the date of official dollarization.
The grace period will give people who live in remote areas time to exchange
their domestic currency for dollars. To reflect this, the United States could
allow dollarizing countries to make a final addition to the initial dollar
amounts of their shares of seigniorage one year after the date of official
dollarization.
Implementing dollarization in the dollarizing country: Besides the
monetary base, other assets, liabilities, and prices will also be expressed in
terms of dollars. For bookkeeping purposes, assets, liabilities, and prices will
be converted on the books from domestic currency into dollars at the exchange
rate that the government has set. In dollar terms, they will presumably have the
same value that they had before. The only difference will be that now they will
be expressed in dollars, which are a more stable unit of account.
By the day a country becomes officially dollarized, laws making the domestic
currency a legal tender will cease to apply, although the government of the
country may continue for some time afterwards to accept domestic currency in
circulation and pay out dollars in exchange. The dollar should be made a legal
tender but, in keeping with the voluntary nature of the standing offer, the
United States should not pressure any dollarizing country to make it a forced
tender. A legal tender is a currency that may legally be used in transactions
between consenting parties, whereas a forced tender is a currency that people
are legally required to accept even if they do not want it. It is possible for
multiple currencies to be legal tender at the same time, though the notes of one
currency will tend to dominate in circulation.
The rate of return for paying seigniorage: What rate of return (interest rate) should be used to calculate seigniorage? As has been mentioned, one way to think of the dollar monetary base is as being like Treasury securities, but paying zero interest. This suggests using the interest rate on some kind of Treasury security to calculate the gross seigniorage of dollarization. The Federal Reserve System pays out seigniorage to the Treasury weekly. If many countries become dollarized, weekly payments to them could be administratively complicated. Quarterly payments
|
Table 3. Statistics Relevant to Seigniorage from the Dollar, 1990 to 1999 | |||||||
|
Year |
Monetary base, end of year ($bn) |
Average currency in circulation ($bn) |
Average interest rate, 90-day Treasury bill (%) |
Federal Reserve gross expenses ($bn) |
Federal Reserve net expenses ($bn) |
Federal Reserve payments to Treasury ($bn) |
Federal budget ($bn) |
|
1990 |
325.6 |
246.8 |
7.51 |
1.5 |
0.6 |
24.3 |
1253.2 |
|
1991 |
337.2 |
267.3 |
5.42 |
1.6 |
0.7 |
19.2 |
1324.4 |
|
1992 |
366.8 |
292.9 |
3.45 |
1.7 |
0.7 |
22.9 |
1381.7 |
|
1993 |
400.2 |
322.2 |
3.02 |
1.8 |
0.9 |
14.9 |
1409.4 |
|
1994 |
434.6 |
345.3 |
4.29 |
2.0 |
1.0 |
18.0 |
1461.7 |
|
1995 |
453.8 |
372.4 |
5.51 |
2.0 |
1.0 |
23.4 |
1515.7 |
|
1996 |
475.2 |
394.9 |
5.02 |
2.1 |
1.1 |
20.5 |
1560.5 |
|
1997 |
513.2 |
425.5 |
5.07 |
2.2 est. |
1.1 est. |
19.6 |
1601.2 |
|
1998 |
528.6 |
460.1 |
4.81 |
2.2 est. |
1.1 est. |
24.5 |
1652.6 |
|
1999 |
-- |
-- |
-- |
-- |
-- |
25.4 est. |
1727.1 est. |
|
Sources: IMF 1999, line 14 (monetary base--the IMF calls it "reserve money"); Economic Report of the President 1999, pp. 408, 412, 419 (currency in circulation, interest rate, Federal budget); Federal Reserve System, various issues (Federal Reserve gross and net expenses); Historical Tables 1999, pp. 40-1 (Federal Reserve payments to Treasury). Notes: Monetary base for 1998 is November. Net expenses (column 5) are those not covered by fees collected for clearing checks and performing other services. Federal Reserve payments to the Treasury are mainly seigniorage, but also include the Federal Reserve System's gains or losses from trading Treasury securities and foreign currency. | |||||||
seem reasonable. If seigniorage is paid quarterly, a logical choice is to
instruct the Federal Reserve System to calculate the rate of return on the
monetary base using the average rate of the 90-day Treasury bill. The Federal
Reserve will pay interest on the part of currency in circulation that the
dollarizing country has exchanged for dollars, sharing seigniorage according to
a formula in the next section.
The economist Robert Barro (1999) has suggested an alternative way of
calculating and sharing seigniorage, which does not involve using an interest
rate. He uses Argentina as an example since it is now debating dollarization.
Under his plan, if Argentina had peso notes equivalent to $16 billion, it would
give them to the Federal Reserve System in exchange for $16 billion in dollar
notes. Unlike this study, Barro would not require Argentina to give the Federal
Reserve any dollar assets and he would make a lump-sum payment up front
instead of making a series of smaller quarterly payments for as long as
Argentina remains dollarized.
The problem with Barro's idea is that Argentina could take the lump-sum
payment, then turn around and reintroduce its domestic currency, cheating the
U.S. government out of $16 billion. The United States would have $16 billion in
peso notes that it could spend, but Argentina could simply print new notes of a
different design and declare the old ones invalid. Similar problems apply if
instead of peso notes the Federal Reserve holds Argentine government bonds.
Argentina seems trustworthy, but not all countries may be.
4. FORMULAS FOR SHARING SEIGNIORAGE
Having analyzed the principles of sharing seigniorage, let us proceed to
formulas that can be used to calculate how to share seigniorage.
Net seigniorage: Recall that gross seigniorage is the revenue earned
from issuing currency before taking expenses into account, while net seigniorage
is what is left after paying for printing notes, minting coins, and employing
the staff of the Federal Reserve System. It is the net seigniorage that can be
shared with other countries. A simple and logical formula to calculate the share
of net seigniorage that a dollarized country will receive from the United States
is:
Dollarized country's dollar share of net seigniorage
= ([total average dollar monetary base over the period
x average interest rate on 90-day Treasury bills during the period]
- net cost of operating the Federal Reserve)
x dollarized country's share of total dollar monetary base
x proportion of seigniorage revenue that the United States pays
If the United States pays 100 percent of the net seigniorage attributed to a
dollarized country's use of the dollar, the last term of the formula is 1 (the
decimal equivalent of 100 percent) and the term drops out of the formula. If the
United States pays 75 percent rather than 100 percent, the last term is instead
0.75.
The share of a dollarized country in the total dollar monetary base will be
determined when it becomes dollarized. (If only currency in circulation counts
as the basis for calculating shares in seigniorage, one could use total dollar
currency in circulation instead of the total dollar monetary base. That would
change the percentages for each country but not the dollar amounts of the shares
of seigniorage.) Using Argentina as an example again, suppose it becomes
officially dollarized on January 1, 2000, and that all the calculations are made
on the basis of the calendar year. Suppose further that the dollar monetary base
on December 31, 1999 is $550 billion. To dollarize, the Argentine government
gives to the Federal Reserve System Treasury securities totalling $16 billion,
the amount of Argentine peso currency in circulation (notes and coins outside
banks) that the public has exchanged. In return, the Argentine government
receives $16 billion of dollar notes. Argentina's dollarization raises the total
monetary base to $566 billion, so
Argentina's share of total average dollar monetary base
= $16 billion ÷ $566 billion
= 0.028, or 2.8 percent
(These numbers, though only examples, are fairly close to the actual numbers.
The numbers in the examples will sometimes be rounded off.)
For many years the dollar monetary base has grown by 5-10 percent a year,
partly from higher demand for dollars in the United States and partly from
higher demand abroad. Argentina will share the increased seigniorage that comes
from an increased circulation of dollars. Its share will be proportional to the
share of the total dollar monetary base it had when it became dollarized. So, if
no new countries become dollarized in 2000, Argentina will still be credited
with 2.8 percent of the total (in decimals, 0.028). Suppose that the average
interest rate on 90-day Treasury bills is 5 percent a year (in decimals, 0.05),
which is above the current level of about 4.25 percent a year but is in line
with the average level for 1996 to 1998. Suppose further that the net cost of
operating the Federal Reserve remains $1 billion, and that the average monetary
base during 2000 is $580 billion. Plugging these numbers into the formula for
net seigniorage yields:
Argentina's dollar share of net seigniorage
= ([$580 billion x 0.05] - $1 billion) x 0.028 x 1
= ($29 billion - $1 billion) x 0.028 x 1
= $784 million
Adding new dollarizing countries: The figure of $580 billion is
assumed to be the average for the entire year 2000. Suppose that the
amount of the dollar monetary base on December 31, 2000 is $600 billion.
Argentina will be credited with 2.8 percent ($16.8 billion). Now suppose that on
January 1, 2001, Brazil dollarizes, and that its action adds $50 billion to the
monetary base, raising the monetary base immediately to $650 billion. The shares
of the total monetary base will be recalculated to acknowledge Brazil's
presence. Instead of being assigned a share of 2.8 percent ($16.8 billion ÷ $600
billion), Argentina will now be assigned a share of about 2.58 percent ($16.8
billion ÷ $650 billion). Argentina's percentage share of the total dollar
monetary base will change, but the dollar amount of its share will remain $16.8
billion. The addition of Brazil will not change the dollar amount of Argentina's
share, nor will it change the amount of seigniorage that Argentina receives, if
the cost per dollar of issuing dollars is constant. If, as is likely, there are
some economies of scale in issuing dollars, so that the costs of issue do not
rise quite as fast as the increase in the total dollar monetary base, then
Brazil's decision to dollarize will generate a slight savings in costs.
Argentina, Brazil, and the United States will share the savings in the form of
slightly higher net seigniorage.
If Brazil reintroduces a domestic currency or otherwise becomes ineligible
for seigniorage, the division of seigniorage will be recalculated to give the
United States, Argentina, and other remaining dollarized countries a
proportionally bigger share. So, if adding Brazil as a dollarized country caused
Argentina's share of net seigniorage to fall from 2.8 percent to 2.58 percent,
dropping Brazil will raise Argentina's share back to 2.8 percent, assuming that
no new countries have dollarized in the meantime. Note that if a country
reintroduces a domestic currency, the total dollar monetary base does not
necessarily fall. The people of the country may well hold onto dollar notes as
"mattress money" if they do not trust the reintroduced domestic currency. Short
of searching everyone's house, the government may not be able to acquire the
dollars it dispersed to the public when it dollarized.
Already dollarized economies: What about economies that are already
dollarized? Seven--the Marshall Islands, Micronesia, Palau, Panama, Pitcairn
Island (a negligible case), the Turks and Caicos Islands, and the British Virgin
Islands--are not U.S. possessions and so receive no seigniorage directly or
indirectly. Their combined population is fewer than 3 million and their combined
gross domestic product in 1997 was only about $10 billion. Unlike newly
dollarizing countries, they have in effect already given up dollar assets in
exchange for currency in circulation. We cannot know precisely how large the
circulation is, so it is necessary to estimate. Perhaps the simplest way to do
so is to assume that already dollarized countries are average in terms of their
ratio of currency in circulation to gross domestic product. This would put them
in the range of 4 to 6 percent of GDP; let us use a figure of 5 percent (in
decimals, 0.05). The formula for calculating the dollar amount of estimated
currency in circulation for an already dollarized economy is then:
Estimated currency in circulation of an already dollarized economy
= GDP x world average currency in circulation as a percentage of GDP
For 1999, the total GDP of already dollarized economies that are not U.S.
possessions should be roughly $11 billion. Total estimated currency in
circulation for those economies is:
Estimated currency in circulation for non-U.S. already dollarized economies
= $11 billion x 0.05
= $550 million
Suppose again that the average interest rate on 90-day Treasury bills is
again 5 percent a year (in decimals, 0.05), and that the United States pays 100
percent of the net seigniorage attributable to a dollarized country's use of the
dollar. The seigniorage that the United States will share with the already
dollarized countries that are not U.S. possessions will then be
Dollar share of seigniorage for non-U.S. already dollarized economies
= $550 million x 0.05 x 1
= $27.5 million
Panama will receive almost 90 percent of that amount because its economy is
such a large proportion of the total. The whole amount, though, is minuscule
compared to the roughly $25 billion of total seigniorage from dollarization, and
"grandfathering" already dollarized economies into the arrangement to share
seigniorage will merely reduce slightly the increase of $900 million in
expected Federal Reserve payments to the Treasury this year.
Why these formulas? The formulas are quite simple. That is their
appeal: because they involve easily verifiable numbers, countries that are
considering dollarization will know what to expect if they dollarize, and there
will be less scope for arguments about how to share seigniorage. To divide the
seigniorage in exact proportion to each dollarized country's use of dollars, the
ideal situation would be to know how many dollar notes and coins are circulating
there. Without a distinct issue of dollars for each country, one that stays
within national boundaries, it is impossible to know the precise amount. In some
countries demand for dollar notes and coins will grow faster than average, in
others slower than average. Because every country will receive an increase in
seigniorage equal to the average increase (excluding the one-time effects of new
countries becoming dollarized), some countries may receive somewhat more
seigniorage and others less than they would if it were possible to determine
with a high degree of accuracy how many dollar notes and coins are circulating
in each country. However, giving every qualifying country a proportional share
of the increase in seigniorage has a rough-and-ready fairness to it because a
high degree of accuracy is out of reach.
Other formulas for sharing seigniorage are conceivable, but involve
difficulties because they are harder to verify and contain more room for
controversy. Estimates of currency usage from household surveys have been
questioned in the United States, because they give much lower figures than the
total of currency actually in circulation. That is the case even though in the
United States the underground economy is estimated to be smaller and notes are
therefore presumably less widely used for illegal payments than they are in many
other countries. Formulas based on estimates of GDP are likewise problematic
because calculating GDP involves many statistical assumptions. Such formulas are
appropriate only for countries that have already been dollarized for many years,
where one cannot use the simple method of basing calculations on the dollars
exchanged for domestic currency in circulation during dollarization.
5. CRITERIA FOR QUALIFYING TO SHARE SEIGNIORAGE
Countries wishing to qualify for sharing seigniorage from dollarization will
require certification by the U.S. government. The criteria for certification
will be simple and uniform.
The purpose of certification will be to ensure that a country has retired its
domestic currency from circulation and that dollars are sufficiently widely used
that the country is contributing significantly to total seigniorage. If people
in the country mainly use the notes and coins of some other currency, such as
the German mark, the country would be receiving seigniorage to which it is not
contributing.
To be certified, a country will need to satisfy economic, legal, and
political criteria. Meeting the criteria will not give a country a right to
seigniorage from dollarization: seigniorage will be a gift of the U.S.
government, not an entitlement. But it will be a gift that is dispensed
according to clear rules established by law, not an arbitrary amount that varies
according to whims.
Economic criteria: There must be a high probability that people in a
dollarizing country will use at least the amount of dollars that comprise a
country's initial share of the total dollar monetary base. Later, the country
must continue to belong to the dollar zone rather than to the zone of another
currency.
Some indications that a country is likely to belong to the dollar zone if
dollarized are that it currently considers the exchange rate with the dollar the
most important exchange rate; it buys and sells mainly dollars when it
intervenes officially in the foreign-exchange market; most exports are priced in
dollars; if foreign-currency deposits are allowed, the dollar is the main
foreign currency held; and dollar notes already circulate more widely in an
unofficial or semi-official manner than the notes of any other foreign currency.
To illustrate, compare Argentina and Bulgaria. Argentina meets all the tests
just mentioned. Bulgaria does not: the exchange rate of the Bulgarian lev is
fixed to the German mark rather than the dollar; the Bulgarian National Bank
buys and sells marks rather than dollars in the foreign-exchange market; most
exports are priced in marks or in euros, the new Western European currency of
which the mark is now a subdivision; and Bulgarians seem to hold more mark notes
than dollar notes. Bulgaria is part of the mark/euro zone rather than the dollar
zone. If Bulgaria were to dollarize, the mark would probably drive the dollar
out of circulation quickly. Sharing seigniorage would give Bulgaria revenue to
which it had contributed little because Bulgarians were not using the dollar.
Argentina or other qualifying countries must have retired at least 75 percent
but no more than 100 percent of domestic currency in circulation and exchanged
it for dollars. (In exceptional cases where there is reason to believe that much
domestic currency in circulation has been destroyed, the U.S. government can
reduce the lower limit below 75 percent.) In exchange for the dollars that have
replaced domestic currency in circulation, the government of the dollarizing
country must have given to the Federal Reserve an equal amount of specified
dollar assets, such as U.S. Treasury securities. The plates used to print
domestic notes and, if applicable, the dies used to make domestic coins must be
destroyed, along with the notes and coins themselves.
There should be a provision to prevent dollarizing countries that have large
excess foreign reserves from engineering big last-minute increases in the dollar
value of domestic currency in circulation just to gain an undeservedly share of
seigniorage. One way to do this is not to count for seigniorage sharing a
greater dollar value of domestic currency in circulation than the average value
for the previous year plus a growth factor of no more than perhaps 10 percent.
At its sole discretion, the U.S. government could allow exceptions in unusual
circumstances: during a currency stabilization following a high inflation, for
example, the dollar value of domestic currency in circulation often increases at
double digit rates as demand for it revives.
Dollarization will be most effective in making the financial system strong if
it is combined with removing exchange controls (which restrict the ability to
buy foreign currency) and opening the financial system so that foreign firms can
compete on an equal basis with domestic firms. As desirable as a more open
financial system is, though, it seems inadvisable to make it a condition for
sharing seigniorage. From an economic standpoint it may be desirable to open the
financial system to foreign participation before dollarizing, but for political
reasons that may be impractical. Countries that have dollarization or currency
boards, which in many ways work like dollarization, have found that if their
financial systems were initially closed, necessity eventually forced them to
allow foreign firms, so as to take full advantage of the international pool of
investment funds.
Legal criteria: The domestic currency must cease to be legal tender,
although the government may continue during a grace period afterwards to pay
dollars for domestic currency in circulation at the exchange rate it has set.
The dollar must have legal tender status, though again, the United States should
not pressure any dollarizing country to make the dollar a forced tender. The
euro and the yen can be legal tender along with the dollar, for instance, even
though the dollar is the dominant currency in circulation.
Should a dollarized country experience a civil war or an invasion there will
be rival parties claiming payment of the country's share of seigniorage.
Procedures for handling such a possibility should be developed, as the U.S.
government has developed them for the general question of diplomatic recognition
of governments during civil war or invasion.
Political criteria: The U.S. government must be convinced that a
dollarizing country is acting in good faith, and is not trying to abuse the
sharing of seigniorage somehow. It seems desirable for the United States to
avoid linking the sharing of seigniorage to unrelated political issues.
Dollarization has benefits for the United States even if the Administration or
the Congress disagree with the policies of a country that is considering
dollarization. Only under carefully specified circumstances, war against the
United States being the most obvious example, should a country that has been
certified be decertified for failure to meet political criteria.
Maintaining certification: To continue to be certified to share
seigniorage from dollarization, a country must continue to meet the criteria, as
determined by a periodic review from the U.S. government. The purpose of the
review is not to use recertification as a political weapon, but merely to
determine whether a country continues to deserve seigniorage because dollars
continue to circulate there. As a way of discouraging the Administration from
using the threat of decertification as a political weapon, decertified countries
can be given the option of appealing decertification to the Congress. However,
some actions will be automatic grounds for immediate decertification without
appeal: reintroduction of a government-issued domestic currency, discrimination
against the dollar in legal tender laws, or war against the United States. A
country that is automatically decertified will forfeit any seigniorage
accumulated since the previous quarter but not yet paid by the United States.
A country decertified on other than automatic grounds will have the option of
negotiating a special bilateral arrangement with the United States to regain
some seigniorage. Take Ukraine as a hypothetical example, since the dollar is
widely used unofficially but Ukraine is close to Western Europe, which uses the
euro. If Ukraine were to dollarize, but simultaneously grant the euro equal
status with the dollar as legal tender, over time the euro might replace the
dollar as the dominant currency in circulation as Ukraine's economy became
highly integrated with the economies of Western Europe. The dollar monetary base
being used in Ukraine might shrink to perhaps half of the amount credited to
Ukraine, so the country would not really be generating anywhere near its
proportional share of dollar seigniorage. In such circumstances, as long as a
Ukraine or another dollarized country continues to use what the U.S. government
estimates to be a significant amount of the dollar monetary base, the U.S.
government can offer to share seigniorage based on some individually negotiated
formula less generous than the standard offer. Also, to give time for bilateral
negotiations to devise a different formula, seigniorage can continue to be paid
according to the standard formula for one year following decertification on
other than automatic grounds. Offering to continue sharing seigniorage for up to
one year after decertification will be a sign that the United States will not
without warning cut foreign governments off from a source of revenue that may be
important to them.
If a country is recertified within three years of decertification, the U.S.
government could, with Congressional approval, award some of the "back
seigniorage" that the country would have earned from being certified
continuously. This provision will allow the United States to reward a government
that reverses course, such as a country that carries out the first stages of
reintroducing a domestic currency, then reverts to official dollarization. After
three years a country will lose the chance to gain back seigniorage. Back
seigniorage will be purely a gift, awarded solely at the discretion of the
United States.
Who would probably qualify: Under the criteria that have been
described, most countries would qualify to share seigniorage if they decided to
dollarize. The main exceptions are a number of countries in Europe and Africa
that are part of the euro zone. Almost all European countries west of Ukraine
either belong to the European Central Bank or give the euro more weight than the
dollar in their exchange rate policy. Where foreign notes are heavily used,
notably in the Balkans, the German mark rather than the dollar predominates.
Africa's CFA franc, which more than a dozen countries use, is pegged to the
French franc, and there are some other African countries such as Morocco whose
circumstances make it likely that the euro rather than the dollar would
predominate if there were no domestically issued currency. (The euro now exists
as a financial unit, but euro notes and coins will not replace the German mark,
French franc, and other currencies until 2002.) But in principle, dollarization
could extend to every country in the Americas, Asia, and the Pacific, plus
almost all the former Soviet Union and half or more of Africa.
How many of those countries would actually dollarize is a different question.
Dollarization probably will have little appeal in countries that already have
good currencies. Singapore, for example, has had low inflation and low interest
rates for many years. It is unlikely to dollarize unless most of the countries
around it do so. But most emerging market countries have currencies that
performed much worse than the Singapore dollar, so for them dollarization is
correspondingly more attractive.
Table 4 shows data on some countries where government officials or the local press have recently shown interest in dollarization.
|
Table 4. Data on Some Candidates for Dollarization | ||||||||
|
Country |
Popu-lation (mn) |
GDP ($bn) |
Budget ($bn) |
Mone-tary base ($bn) |
Curren-cy in circula-tion ($bn) |
Net foreign reserves ($bn) |
Infla-tion rate (%) |
Inter-est rate (%) |
|
Argentina |
36 |
324 |
41.1 |
16.4 |
13.5 |
20.8 |
1.0 |
6.81 |
|
Brazil* |
160 |
804 |
113 |
49.0 |
14.4 |
44.2 |
3.2 |
29.50 |
|
Ecuador* |
12 |
19.8 |
3.38 |
1.23 |
0.51 |
1.62 |
36.1 |
39.3 |
|
El Salvador |
5.9 |
11.2 |
1.39 |
1.85 |
0.40 |
1.76 |
2.5 |
9.43 |
|
Indonesia* |
200 |
215 |
34.4 |
10.1 |
5.2 |
9.9 |
57.6 |
62.79 |
|
Mexico |
96 |
403 |
69.0 |
19.5 |
11.7 |
22.1 |
15.9 |
26.89 |
|
Russia* |
147 |
443 |
78.6 |
13.0 |
9.1 |
-4.5 |
27.8 |
50.6 |
|
Venezuela |
23 |
88.4 |
21.0 |
6.70 |
1.94 |
13.7 |
35.8 |
34.84 |
|
Panama |
2.7 |
8.7 |
2.26 |
n.a. |
n.a. |
0.73 |
0.6 |
6.77 |
|
United States |
268 |
8100 |
1652.6 |
528.6 |
464.0 |
77.5 |
1.5 |
5.35 |
|
Source: IMF 1999, lines ae and rf (exchange rates), 11 and 16c (foreign assets and liabilities of monetary authority), 14 (monetary base--the IMF calls it "reserve money"), 14a (currency in circulation), 60b (interest rate for most countries) or 60l (interest rate for Ecuador, Panama, and Venezuela), 64 (inflation--consumer price index), 82 (budget of national government), 99b (GDP), and 99z (population). Notes: *Countries that have suffered currency crises within the last year. n.a. = not available. Population, GDP (gross domestic product), and budget are 1997; monetary base and foreign reserves are end-1998; inflation and interest rates are the average annual rates for 1998; monetary base, currency in circulation, and net foreign reserves are for the end of 1998. Where the data specified are unavailable, the table uses the most recent prior data. These cases are illustrative, chosen because there has already been some local discussion of the possibility of dollarizing. Panama and the United States are included for comparison. | ||||||||
6. OPTIONS BEYOND THE STANDING OFFER
The standing offer will be open to all qualifying countries. If it seems
prudent, the U.S. government can supplement the standing offer with options
available to selected countries solely at U.S. discretion. The purpose of the
options would be to help countries that might otherwise have difficulty becoming
and remaining dollarized.
Assisting dollarization when reserves are less than 100 percent: The
foreign reserves of many countries are greater than official statistics
indicate, because people already hold considerable amounts of dollar notes and
offshore deposits that escape official detection. It has been the experience of
a number of countries in recent years, including Argentina and Estonia, that a
credible monetary reform can bring dollar notes and offshore deposits into the
domestic banking system. The foreign reserves of the banking system, including
the reserves of the central bank or other monetary authority, increase. Since
dollarization is a highly credible reform, it may well have a similar effect in
many countries.
Even so, there may be cases where a dollarizing country lacks the dollar
assets to convert all domestic currency in circulation into dollars at the going
exchange rate. In such cases, the United States could lend it the shortfall and
keep part or all of the seigniorage in later years to repay the loan. For
example, if a country has domestic currency in circulation equal to $10 billion
at the going exchange rate with the dollar, but only has $5 billion of dollar
assets, the United States could extend a loan for the remaining $5 billion. Then
the country would be able to convert all domestic currency in circulation into
dollars. Instead of paying to the country the seigniorage from the $10 billion,
the Federal Reserve would keep part or all of it until the $5 billion loan had
been repaid with interest.
Such loans have potential problems, which is why they need careful scrutiny
and should require Congressional approval. The United States needs to be
confident that a borrowing country will remain dollarized long enough that the
seigniorage it shares will repay the loan. To help ensure that the loan will be
repaid, the United States should lend no more than 50 percent of the dollars
that a dollarizing country exchanges for its currency in circulation. To reflect
that some element of risk is involved, the loan should carry an interest rate
higher than the rate used to calculate the payment of seigniorage. The rate
should vary according to the likely period of the loan, and should be the rate
for U.S. Treasury securities of the same maturity plus a premium that may vary
from country to country. Countries that default, by ending dollarization before
they have repaid the loan, will be liable for the same sanctions they would face
for defaulting on other U.S. government loans.
If a country reintroduces a domestic currency before its loan is repaid, its
government is unlikely to receive any direct benefit from the presence of
dollars in circulation within the country. In dollarizing, it will have
dispersed dollar notes and coins to the public, and it will have no easy way to
retrieve them. Dollarization in effect disperses foreign reserves that under
other monetary systems are centralized in a central bank or other monetary
authority; recentralizing the reserves can be difficult. If people do not trust
the new domestic currency, they may continue to hold dollar notes as "mattress
money." If so, the United States will receive seigniorage from the dollars even
though the government of the formerly dollarized country has broken its promise.
Allowing seigniorage to be pledged as collateral: Dollarizing countries whose initial dollar reserves are less than 100 percent of domestic currency in circulation will have another option for obtaining additional reserves that does not depend on the U.S. government. Because the revenue from dollarizatio