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April 15, 2008


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Imports are about a third of Canada's GDP as well. I'm not seeing an internal push for Canada to become US-dollarized. Even during the Bretton Woods years, Canada spent more time on the float than in the band. And although the Dominican Republic's economy is much smaller than Canada's, in terms of population, it's as large as Canada west of Ontario -- the areas which benefit most from the float, I suspect.

So the mechanism in favor of dollarization can't be the inherent goodness of a common currency itself.

You mention Panama's success with dollarization. But Panama also shows the risks of dollarization and American interference in local politics -- with the proviso that while Panamanian financial institutions were quite strong, its monetary institutions were exceedingly weak. If strong-armed with the dollar by the United States, the Dominican Republic would simply dust off the printing presses. So why dollarize in the first place?

And I'd think the Bayesian prior for some sort of malign intervention by the United States from the Dominican perspective would be rather high. I don't think it's a question of emotional frisson, but Realpolitik from a small, oft-squashed, nation's viewpoint: a desire to preserve policy flexibility and autonomy in the teeth of neighbors who don't necessarily have one's best interests at heart.

I suppose Denmark vis-a-vis the euro might be another example of this.

Your political analysis makes sense, although I have a quibble and a question.

The quibble is that the costs to Denmark of maintaining monetary autonomy are far larger than for the Dominican Republic, simply because Denmark religiously fixes to the euro while the D.R. floats against the dollar. Danes pay an extra half-percentage point in interest for the privilege, but (in practice) obtain no autonomy as a result.

That is a quibble: as you say, Denmark is paying to retain an option.

The question regards Panama. Why did the country have so little ability to introduce its own currency? After all, Honduras and the D.R. both pulled that off; it's hard to imagine that Panamanian were less intrinsically capable.

I suspect, rather, that it was endogenous: Panama used the dollar --> developed a sophisticated foreign-dominated banking sector based on the dollar (and implicit Fed support for a chunk of the nation's banking system) --> decided that the costs of abandoning the dollar were huge.

That said, I'll know the answer soon enough. When are we going to meet next about the project?

Here's an argument against my own position, Carlos: I'm assuming that a drop in local-currency real interest rates and the elimination of exchange rate risk won't have any effect on investment.

My evidence comes entirely from continuing slow growth in El Salvador.

Does that /really/ follow?

Some random thoughts.

Remittances closing a current account deficit: this is much more common than people seem to realize. In places like Moldova, Albania and Armenia the macro effect of remittances is huge. It's the reason that (for instance) the Armenian dram has been rising against the dollar instead of collapsing miserably. In extreme cases -- and Armenia is fairly extreme -- you get a variant of Dutch disease: the constant remittances make the currency /too/ strong (the strong dram is killing Armenia's diamond polishing industry) and distort the economy in various other ways.

Exchange rate risk: I note in passing that, over the last few years, making non-dollar investments would have been a good idea much more often than not.

Euroization: it doesn't exactly match, because there are big, big non-economic aspects to joining the Eurozone. For most of the new members, it's a sign that they've almost graduated -- the next-to-final step in becoming Really European. (Schengen borders would be the last.) IMO it's /not/ in Hungary or Romania's interest to join the Eurozone; in fact, I don't think they should even be pegging. Hungary's had to do a couple of surprise devaluations already, and Romania has only avoided it by keeping their float loosey-goosey and doing other stuff with interest rates and sterilization.

BTW, you didn't mention Puerto Rico. How does it fit?

Doug M.

Hi, Doug,

Re remittances and the Dutch disease: I wrote a case on the Philippines, much of which dealt exactly with that issue.

Re euroization: one of the problems assessing dollarization v joining the eurozone is that for most E.U. members, as you say, adopting the euro is the last stage of integration. The marginal effect of a common currency --- /once all other barriers have been swept away/ --- might be huge. Most dollarized countries, though, don't sweep away any of those barriers before dollarizing: CAFTA is weak gruel compared to the acquis and the right to appeal to European courts.

And that's why Puerto Rico (and to a slightly-lesser extent the TTPI) is different. It's got free labor mobility, huge government transfers, and a common body of commericial law. It's banks are treated as American banks, and the Fed carriers out lender-of-last-resort functions. Finally, Puerto Rican imports of goods and services come to a full 94 percent of GDP --- if the D.R. was at that level, I'd say that dollarization might be a pretty good idea.

In other words, a separate currency for Puerto Rico would merely raise transaction costs without netting much policy freedom --- unlike the D.R., P.R. is fully integrated into the American economy.

Finally, one last bit of food for thought: joining the euro and euroization aren't quite the same thing. When a country joins the euro it gets access to a lot of ECB services (including, in theory, a share of seigniorage revenue), but a country could adopt the euro without officially joining the ECB. Montenegro and Kosovo would be two clear examples. Unilateral euroization (or joining the eurozone) are very different commitments from simply pegging the exchange rate ... so it isn't necessarily wrong to argue that a country is having trouble with a peg and therefore should consider simply adopting the currency to which its money is pegged.

I'd love a related macro post from you ... what is going on in the pegged E.U. countries and in the euroized Balkan outposts?

DOUG, Is that you????? If so send an email to me. [email protected] I happened to see this blog with your name and am not sure if it's the Dough Muir I knew...pictures look very different.


Regarding Panama, in normal situations, there would be few positive reasons to make a changeover to an independent currency, and a number of negative ones. In my opinion, the most important negative effect is also the least quantifiable: an independent balboa would be considered a negative signal to investors and foreign users of Panamanian services. But there would be subtler effects, having to do with the unusual service-based structure of the Panamanian economy. The easiest way to avoid them would be for the services to remain dollar denominated -- so why change? It would not help Panamanian political stability to have a balboa-dollar exchange rate affect employer-employee relations in their service industries.

The abnormal situation, a monetary embargo, was literally a once in a century event. There, an independent currency -- let us call it the piña -- would have alleviated much of the effects of the Abrams-induced depression. But the benefits of the piña would in my opinion be balanced, and perhaps overwhelmed, by the signal this would send to the foreign users of Panamanian services at that time. It's hard to say, because an undetermined amount of Panama's service economy at the time centered around narcodollars, and one assumes that the risk preference of drug traffickers are a little off the norm. But I'm having difficulty seeing Big Al in Cali seeing the piña as a positive development.

This week is resume hell. Chicken bus next week?

Short on time at the moment, but let me throw out a tidbit. Back in February, when Kosovo was about to declare independence, everyone was worried about Serbia closing the border.

Since the majority of Kosovo's imports come from Serbia, and the plurality of its exports too (such as they are), this would have been a major disaster for Kosovo. And not one they could easily deal with, either; Kosovo is kind of a cul-de-sac. The border with Albania is all mountains, with only a couple of crappy two-lane roads, and there's just one not-so-great rail link to Macedonia.

But I said the Serbs wouldn't do it, and I was right. Two reasons. One, most of the trade with Kosovo takes place with southern Serbia -- the most nationalist and conservative part of the country, as it happens. So, an embargo would suck money from the pockets of... the supporters of the parties who'd be pushing an embargo. Politically, they'd be shooting themselves in the foot.

Second reason: Kosovo's on the Euro! Serbia runs a huge trade deficit with the Eurozone, but Kosovo runs a big trade deficit with Serbia. The Kosovo trade doesn't close the deficit, but it makes it a lot less uneven than it would be otherwise. If the border closed, and those Kosovar Euros stopped flowing in, the Serbian Central Bank would find itself in a rather ugly situation.

Okay, must read to little boy now. More perhaps anon.

Doug M.

Doug, HDTD desperately needs a euroization post from you. Desperately.

At least I'd like one. Or two, maybe three. It's a big topic.

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