TED Case Studies

The Threat of the Dollar

Dollar Globe

TED Home Page About TED Research Projects Sort Cases
Cases Issue Papers Site Index

US Money US Money

I. Identification

1. The Issue

In an age of increasing globalization, unlike any before, countries feel more pressure to open all aspects of their economies. There is a large movement towards regionalism in the form of national free trade associations. There is money to make, markets to tap and trade alliances to form. No one wants to be left behind in this revolution. Countries feel the pressure to either join the revolution or fall farther behind developmentally. Dollarization, which is when a foreign country adopts the United States currency as its main form of currency, is at the intersection of these pressures. Ironically, though, this pressure to liberalize is causing many countries to cling tighter to their cultural heritage. This problem of how best to face this duality is most real in the Western Hemisphere, in Latin America and the Caribbean, where proximity turns up the threat of cultural assimilation. They not only have to contend with "the giant of the North" as a neighbor, but also with the added pressures of how best to grow their economies in today's global climate. Dollarization is the proposed panacea. Ecuador is a believer.

2. Description

The US Dollar has been in wide circulation in Latin America for at least a century, though the discussion of dollarization has not so wide-spread or seriously considered. Panama is the exception. Their dollarized economy holds roots in the US-assisted independence of 1904 *. The size of the country and the close US links, due to the Canal Zone, made the rest of Latin America, and most of the world, view it as a unique case (Rohter, 2000). Generally, though, the serious discussion of dollarization in Latin America is a recent, and always controversial, occurrence. When Ecuadorean President Jamil Mahuad, a Harvard-educated lawyer, proposed dollarization in early January of 2000, havoc erupted. Though many of Ecuador's banks and businesses supported the move, the country's three highest Central Bank officials stepped down in protest to this "irrational change in policy." The officials included the bank president and his top two deputies. This resistence is unsurprising, though, since dollarization would render the Central Bank generally unnecessary, except for participating in the foreign exchange markets for the sole purpose of exchanging sucres for dollars (Rohter, 2000).
Protestors in Quito
Ecuadoreans protesting on January 10 in Quito against proposed dollarization

A coalition of student, labor, Indian and political groups also protested. The Indian group alone represents about one-third of the country's population. They went on a general strike and decended upon the capital city of Quito, contending that dollarization would lead to "mass impoverishment." Their demands included that "the government, the Parliament, the courts,...all [had] to go and the Ecudorean people save themselves [through a unity government]." The Indian group had already established a parliament for this unity government, attacking Mahuad's plan as "dollariz[ing] poverty, privitiz[ing] wealth and repress[ing] the resistance (Rohter, 2000)."

There are several reasons for the current interest in and for current concern over dollarization. All of them based in the increased global interconnectivity and competition. These reasons include a change in the global market structures, the emergence of the Euro, viable competitiveness, financial crises, and the Ecuadorean dollarization (Rohter, 2000).

The first reason for the interest in dollarization is the changed market structure. Even though globalization is not new, the form it is currently taking is a change from the modus operandi of the past few decades. According to economist Guillermo Calvo, 1989 is the base year of the integration of Emerging Markets (EMs)into the world private financial markets. EMs now operate under

The introduction of the Euro to the world's financial markets in 1999 made the idea of one currency for numerous countries seem possible, and attractive. The euro managed to stabilize Spain and Portugal, providing lower inflation rates and rapid growth, according to Ricardo Hausmann, chief economist of the Inter-American Development Bank. He also said that "[i]f a monetary treaty can be negotiated, it could be attractive for Latin America (Rohter, 2000). The Euro also made other nations more than a little nervous as to how they would manage to compete with this new, and strengthening, currency. These factors led the US, Canada, Mexico, Argentina, Chile, Brazil, and Columbia to begin to explore the feasibility of creating the "Amero" as a counterpart to the Euro. The "Amero" would be a common currency, not necessarily the US dollar, that all of the countries in the Americas would use as their own. Dollarization, in this instance, is a stepping stone to the proposed "Amero."
FTAA emblem
Free Trade Area of the Americas emblem

Dollarization is also a proposed stepping stone to an Free Trade Area of the Americas. Regional trading blocs are quite common now, and provide numerous economic and social benefits, as well as problems, to their members (Dollarization or regional currency, 1999). While some say that the cost of dollarization would be terribly high, the reality is that partial dollarization had already occurred, even though full, official dollarization was not an open topic of conversation. The dollarization that has occurred so far is market driven. Market driven dollarization is a natural process in which the government takes no active or direct role (Shu-ki, 1998).

Another reason for this consideration has to do with the recent series of financial crises, including the devaluation of the Brazilian real in 1998 and the Mexican peso in 1994. These events hit Argentina almost the hardest, since it has close financial and commercial ties with both countries. It is also one of the most serious countries about dollarizing. Even still, it is not for certain that even Argentina will adopt the Dollar as its primary currency any time soon (Dollarization or regional currency, 1999).

Dollarization would not be such a big step for most Latin American states. Many of their economies and banking systems already operate largely on the Dollar or concurrent to the dollar. The Honduran banks are one good example. They recorded a 300% increase in savings in US Dollars from 1995 to 1999.

There are a few reasons for this high level of dollar savings. One, perhaps more minor, has to do with the strong familial Latino culture. Workers go to the United States from all parts of Central and South America and then send part of their salaries to help out family members "back home," where work is scarce and low-paying (Savings in Dollars Grows, 1999). Another, more important reason, has to do with loans. There is a standard regulation that requires banks to keep their liabilities and assets in the same currency to avoid the risk associated with currency fluctuation.
Migrant workers
Latino migrant workers harvesting lettuce in the San Joaquin Valley, California, USA
Consequently, EM bank loans tend to be heavily dollarized, which is associated with a phenomenon called Liability Dollarization (LD), i.e., sizable dollar debts. In Argentina, Peru and Bolivia, most of the local private sector deposits are in dollars and the banks do most of their medium and long term lending in dollars (Experts discuss pros and cons of dollarization, 1999). Their supermarkets already give change in both US and local currency. In El Salvador, "dollar remittances from Salvadoran in the United States are now the principal source of foreign exchange (Rohter, 2000)."

The latest reason is the current dollarization move in Ecuador. In response to the worst economic conditions the country has faced in 70 years, Ecuadorean President Jamil Mahuad decided to dollarize his country's economy, hoping to stabilize it. He announced his plans on January 9, 2000, after a full year of economic turmoil, in which the government felt it was necessary to freeze all savings accounts to minimize damages. This move towards dollarization generated ripples beyond Ecuador's borders. The whole region is now forced into a debate over monetary policy and Latin American-United States economic relations. It is the test that dollarization advocates have been waiting for (Rohter, 2000).

Now that dollarization is on the table, countries and financial experts are presenting numerous reasons why implementing dollarization would be a good idea. These reasons include easing into regional trade groups, increasing financial stability, improving the business environment, improving fiscal discipline, and increasing investment.

One idea is that having the entire hemisphere on a single currency would ease the transition into trade groups such as Mercosur or a Free Trade Area of the Americas. A common currency would greatly reduce some vicious competition between countries and facilitate trade agreements. Mercosur, a customs union including Argentina, Brazil, Paraguay and Uruguay, has considered adopting a single currency (Goldman, 1999).

Another suggestion is that dollarization would also provide stability to the characteristically volatile Latin currency markets. The former El Salvadoran finance minister testified to the US Joint Economic Committee that "dollarization would remove one of the most daunting obstacles for the development of Latin American economies - their protracted instability and propensity to exchange-rate fluctuations (Goldman, 1999)." When Ecuador decided to dollarize, President Mahuad recommended fixing the rate of exchange at 25,000 sucre to the dollar. Patricio Proano, formerly the Ecuadorean central bank's assistant manager, protested that this rate was unrealistic. The rate was closer to 30,000 sucres to the dollar, which some analysts said was still short of the level that would discourage speculators from testing the plan (Rohter, 2000). This does not contribute to currency stability.

It is this issue of increased stability which the US supports. The administration, including Federal Reserve Chairman, Alan Greenspan, believes that if dollarization would help to achieve economic stabilization in these countries, then it would be in the US' best economic interests. As of April of 1999, no countries had formally approached the US about converting their currencies to the US dollar. But, Greenspan said that though he supported dollarization, the Fed would "not change domestic interest rates to help other countries if that would hurt the United States (CNNfn, 1999).

The process of implementing dollarization could be costly, due to the expense of aligning policy, but it would provide a short cut to monetary and financial stability. This volatility is higher in systems with a higher need for information, since the information they receive is imperfect or asymmetric. A dollarized system has a low need for information, so would be more stable (Calvo, 2000).

Dollarizing the public debt would also keep inflation at an optimal level since it would remove the incentive to devalue currency. Currently, leaders in developing states face the temptation to devalue currency in an effort to appease their constituency (Calvo, 2000). The flaw in this argument is that dollarization would prevent leaders from trying to manipulate currency within their own borders. This may or may not happen. While dollarization limits a leader's control of monetary and fiscal policy, it does not rule out a fundamental alteration to the system.
Former Ecuadorean President Jamil Mahuad
Former Ecuadorean President Jamil Mahuad

Several aspects of the Ecuadorean example question the belief of the stabilizing effect of dollarization in Latin America. One is the behavior of the President. When President Mahuad decided to dollarize, he called for the resignation of his entire 15 member cabinet. Under dollarization, the president could just as easily move people around, which does not increase stability. Analysts also claimed that Mahuad's dollarization proposal was his last resort in trying to end the calls for his resignation (from 53% of the population) ; the move was made more out of political expediency than ideological conviction. Of course, the people were calling for his resignation because of the economic problems. In 1999, the economy contracted more than 7 percent, inflation was over 60 percent, the country defaulted on $13 billion of foreign debt, and the currency lost 67 percent of its value against the dollar. Simon Pachano, a professor at the Latin American Faculty of Social Sciences in Quito, was not alone in thinking this was a red herring. "With this measure, Mahuad has been successful in changing the national agenda, removing his person as the focus of debate and substituting something else." After he announced his plan, polls showed that 60 percent of Ecuadoreans supported the dollarization measure, and wanted to see it through. Even the protestors shifted their attention from criticizing Mahuad to attacking the dollarization plan. The proposal was also an attempt to maintain power. When Mahuad presented dollarization before the Ecuadorean Central Bank for approval, he threatened to fire any official who opposed it.

The second aspect is the behavior of the congress and constituency. In 1997, the country had three presidents within the course of one week. Congress threw one out claiming he was mentally incompitent, and another faced corruption charges, fled to Panama, but is now absolved of the charges due to a political deal between his party and Mahuad. As the protestors prove, the public is also easily distracted (Rohter, 2000).

The proposed economic stability is closely connected with another possible benefit, improving business. Dollarization would free the businessman of his worries about shifts in the dollar. This would allow him to concentrate more on the actual business operations, confident in the financial long term. It would also lower business transaction costs for both the domestic and foreign internationally operating businesses (Goldman, 1999). This increased economic integration would create trade opportunities for those economies and US companies. "The United States has a lot to gain, given that these countries are fertile ground for absorbing US exports," Calvo said. Again, the question of dollarization providing a stable environment arises. Dollarization might free the businessman of currency fluctuation worries, but it does little to promise political stability.

Some government experts also believe that it would help Latin countries to improve their fiscal discipline. The reasoning here is that these countries would be forced to behave like the US by matching its fiscal policy. These countries would have to adjust their cost structures to ensure that their currency remains representative of the US dollar. In November of 1998, however, Greenspan questioned "whether a sovereign nation, otherwise inclined to economic policies that are 'off the wagon,' can force itself into 'sobriety' by dollarization (Goldman, 1999)." The Treasury department said that it was closely watching Ecuador's progress. "Strong underlying economic policies, including policies to ensure sound banking sector and public finances, will be essential for Ecuador to achieve economic and financial confidence," according to one senior Treasury official. Some economists warn that a "quick monetary fi[x]" like dollarization is no substitute for improving fiscal policies. Should that be a prerequisite to the transition, or will dollarization force it to happen? This is a chicken or egg debate*.

Finally, the dollarization proponents, including the US Congressional Joint Economic Committee, believe that this process would produce higher rates of investment due to the resulting lower average interest rates and longer maturity of loans. This would supposedly increase the level of the population's access to housing and other durable goods. The result would be a substantive increase in social equality. Social benefits, pension funds, and other savings would gain protection from the current volatile currency market (Dollarization or regional currency, 1999). Currently, workers in these countries watch their earning power eroding in high inflation and weak currency. Not to mention the fact that while they recieve pay in local wages, executives recieve it in dollars (Rohter, 2000).

Shortly after announcing dollarization, though, Ecuador experienced a little trouble in securing a $250 million loan from the International Monetary Fund (IMF). The IMF said that if the Ecuadorean government were going to adopt a different economic policy, then negotiations for the loan would have to start all over again (Rohter, 2000). The IMF, World Bank, the Inter-American Development Bank and the Andean Development Corporation wound up promising a $2 billion joint loan to Ecuador.

Uncle Sam holding out a Dollar Bill
The US would offer little to assist dollarized economies without a negotiated agreement

The biggest threat of dollarization, from the Latin American perspective, is these countries would lose control of their monetary policies, leaving them unable to make any adjustments, i.e. expand or contract money supply, in times of economic crisis. The Co-Chairman of Citigroup, Inc., John Reed, said that while countries adopting the dollar "may lose some flexibility in domestic policy issues," this would be offset by increased investment and capital flows. "Full dollarization, if credible, eliminates devaluation risk, and, consequently, will likely result in interest rates which are both lower and less sensitive to crisis in other countries," according to Guillermo Calvo, director of the Center for International Economics at the University of Maryland, and former IMF advisor. Countries really do need to maintain enough fiscal freedom to adjust to economic imbalances. This freedom to adjust their monetary policy provides states with an additional "buffer" zone against US economic "shocks." Though they would save themselves the cost of determining an exchange rate, any adjustment in response to the Dollar's status would imply an enormous social cost (Dollarization or regional currency, 1999). This loss of independence is a direct threat to the national sovereignty and identity that Latin Americans hold so dear.

Another frightening aspect of a dollarized system, under current conditions, is the amount of financial policy detachment between the US and Latin America. The US is a "dollar economy with a unlimited funds to prevent a serious collapse in stock market prices (Calvo, 2000)." However, that only includes the US stock market. Unless countries negotiate some agreement with the US before dollarizing, they will have a small safety net. At the same time that Greenspan referred to the Latino fiscal and monetary policies as "drunk," US Treasury Secretary Lawrence Summers made it clear that the US would deem it inappropriate to

This sends a clear message to those states considering dollarization that the US is unwilling to extend the Federal Reserve system safety net to any dollarized economy in trouble. The Fed would also not take the cyclical differences between Latin America and the United States into account in its monetary policy (Rohter, 2000).
Looking at a sheet of US dollars
An inspector examines a sheet of uncut US Currency

While dollarized economies would save themselves whatever expense is involved in printing and minting money, they would have to pay a "seignorage" fee to the US. This means that, despite the fact that it costs only pennies to manufacture paper bills and metal coins, they would be sold at face value. The result is that the American Treasury will make a substantial profit of several billion dollars per annum, if the whole region dollarized, unless they negotiated treaties to waive these fees. But neither Ecuador, nor any other country considering dollarization has formally approached the US about negotiating any such treaty (Goldman, 1999), even though the US has expressed the hopes that such countries would consult the US in advance (Rohter, 2000).

A tight bond would spread any dip in the US economy to other Dollar-based systems (Experts discuss pros and cons of dollarization, 1999), without providing them with the tools to protect themselves. As it is now, when the US catches a cold, the world catches pneumonia. It also gives the United States an economic weapon against disagreeable or uncooperative countries, witholding dollars as the Bush administration did with Panama in its effort to oust General Manuel Noriega (Rohter, 2000). Countries must ask themselves how committed they want to be, before they dollarize.

Some question if these countries can even currently, truly "dollarize." These devil's advocates point out that a "dollarized" Latin state would not be able to print the money, nor would the US Federal Reserve be willing to guarantee the performance of its currency in all the "dollarized" countries in the hemisphere. When Ecuador approached the idea of dollarizing, the US Treasury Department did encourage the idea, nor did they oppose it, not publicly anyway (Rohter, 2000).

Essentially, these countries would be risking their economies with limited or no options of influencing interest rates or currency levels. The President of the Inter-American Development Bank and the US Treasury also question if the Latin states even have the necessary environmental conditions to dollarize. While Latin America has reason to worry about getting too close to the States, the US worries much the same about Latin America. These countries must first develop a system to converge their macroeconomic policies before they can adopt a common currency. Gustavo Indart, pundit at the University of Toronto, believes that the US and Latin American countries are not ready for a common market, yet, since their economies are so very different.
Fed chief Alan Greenspan
Is Ecuador ready to put Alan Greenspan in charge of their money supply?
Dollarization in the Americas "stands in sharp contrast" to the European Union experience, since that involved a group of countries at similar levels of economic development (Rohter, 2000). Yet even they had tremendous difficulties in unification, and still have problems due to differing business cycles, exchange rate and monetary coordination, and economic policy frameworks and outlooks (Hirst & Thompson, 1996). All these problems, and they at least have a common central bank to manage their common money. In addition, a common monetary policy at this point would not solve Latin American economic problems, which are due more to fiscal and banking mismanagement than monetary issues (Experts discuss pros and cons of dollarization, 1999). Economic advisors cannot control politicians' spending or political activity. It is not that their financial imbalances are unsustainable, it is that their policies are unsustainable.

A currency union should be the last step in the "ongoing market-led process of regional financial integration (Experts discuss pros and cons of dollarization, 1999). For now, though, full dollarization is inadvisable, since it would be a matter of over investing in a market over which Latin American countries have no control. Argentina's system of pegging their currency to the dollar allows the country a little cushion against extreme interest rate volatility, allowing for autonomous monetary policy management (Shu-ki, 1998). Conditions are not ripe for dollarization. Virginia Fierro, the former general manager of Ecuador's central bank warned, as she stepped down, that "conditions to dollarize the [Ecuadorean] economy do not yet exist (Rohter, 2000)." Economists and researchers currently estimate that it will be at least twenty years until the Americas are ready for a monetary union (Dollarization or regional currency, 1999).

Many of the US spokespeople are vocal advocates of dollarization. Though they give a great list of benefits of dollarization to the local economies, it most likely boils down to creating an ideal production environment for US and other outside companies. While this presence does provide jobs, it still does nothing to ensure that companies will improve workplace conditions in these countries, nor that they will invest in the local or national community. Some say that where US and UK military colonization failed, the US has imposed itself on Latin America through a capitalistic imperialism, of which the Dollarization movement may be part. In fact, Robert Rojas stated in his book, Latin American: Blockages to Development, that the main reason that the US was so active in Latin America in this century was due to the belief that the entire hemisphere was the rightful sphere of US influence (Rojas, 1984).

Though dollarization sounds like a nicely packaged approach from the US perspective, nothing is ever so simple. Dollarization would be good for the US since it would create a more stable hemispheric economic environment and enhance trade regionally. The problem is that dollarization would make the US at least partially responsible for those dollarized economies (Goldman, 1999). This is a prospect that the Latin American countries dread, but the US does not relish, either. Historically, the US culture has cherished the idea of remaining global political third party, while trading with as many "involved" parties as possible. The US culture was never one that approved colonies, not just because of the US' own colonial roots, but also because such dependants would cramp the US' independent, individualistic style. Less dependants means less territory to fight for and fewer people to take care of, generally. Any power that the world might perceive the US as having would be balanced out by the burden of extra economies to monitor.

The Clinton administration has expressed concerns over the additional burden that the mechanics of the process might generate. The US would be "buying the problems" of those countries that dollarized. According to Alan Greenspan, the US "would never put [itself] in a position where [it] envisioned actions that [it] would take would be of assistance to the rest of the world but to the detriment of the United States." And while Latin America has cause for concern over the power that the US would weild in their economies, the US fears that Latin American economic frustration and resentment could at the US (Rohter, 2000). After those countries dollarize, there is no predicting if the governments or people will turn and attack the US for the failure of a plan that 'seemed like a good idea at the time,' due to some form of eroding national responsibility.
Latin American liberator, Simon Bolivar
Simon Bolivar is considered the liberator of Latin America. The same feelings that he inspires in Latin Americans, Antonio Jose de Sucre, Bolivar's chief lieutenant inspires in Ecuadoreans.

Another thing that these policy makers, bankers and economists may not be taking into consideration is the extent of cultural influence in Latino life. For one thing, dollarization threatens an important expression of cultural identity in those countries considering dollarization, as well as within the United States. In the strongly independent and paternalistic Latino culture, dollarization threatens to remove several cultural symbols. The sucre, itself, is a national symbol. Marshal Antonio Jose de Sucre is an Ecuadorean national hero. Sucre was Simon Bolivar's chief lieutenant and a hailed military genius. He won victories at Pichincha, Ecuador and at Junin and Ayacucho, Peru. The victory at the latter assured South America's independence. He then became the president of Bolivia, and fought off a Peruvian invasion of Ecuador (Archipielago, 2000).

Secondly, dollarization proponents continue to show their shallow understanding in this issue of the importance of culture. Members of the Congressional Joint Economic Committee, for example, think that it would be a great idea for these central governments to "abandon their national currencies" for the US dollar (Goldman, 1999). Such an approach not only makes light of this symbol of a nation's pride, something that not only represents the value of a country's economy, but also portrays its national heroes and their sacrifices for freedom. This approach also attacks the manhood of the Latin American state. Dollarizing holds not just the implication of a stabilized economy, but rather shames a people in the eyes of the world. It seems to say, "we tried to do this on our own, but failed." The result is a sort of fiscal and monetary impotence. Their systems relying on the US currency much as a faint woman rests on the arm of strong man. Perhaps this imagery seems a little politically incorrect, but I use it purposefully. Though the Latin culture is changing somewhat from this, their culture still operates around strongly defined gender-typing. A man is strong and stands on his own feet; a woman needs him. While Ecuadorean President Mahuad used this cultural aspect to defend his dollarization plan with the machismo language of "Ecuador does not need timid measures" and "I have been slow to act, [b]ut I have my foot on the accelorator now," other Ecuadoreans held a different perspective. Prominent economic analyst and political commentator, Alberto Acosta saw it as a sign of weakness. "This is an act of desparation in the face of a crisis that is spinning out of control, an attempt to remain in power despite the loss of public support. It is the unconditional currender of a country that recognizes its own inability to conduct a monetary policy on its own." The military had no respect for him, and were "amazed" that they had to defend someone they viewed as corrupt and inefficient (Rohter, 2000). The idea of dollarizing sounds great in numbers, but there are deep cultural issues to contend with, too. It is these issues that Argentina's and Ecuador's leaders had to face. They wished to act in their countries' best financial development interests, but their citizens were a little uncomfortable.

Third, the fact that those formulating dollarization believe that it will increase economic equality demonstrates the depth of their knowledge of the cultural circumstances that led to this social inequality. This whole discussion may be distracting policy makers from the real problems and issues in Latin countries' financial states. Ruben Mendoza, the Director of the Office of Rosk/Country for Latin America of the Royal Bank of Canada, thinks that the items that Latin states should be addressing are the "high levels of fiscal, monetary and exchange rate imbalances, the poor distribution of incomes, the lack of productivity and the poor use of investments (Dollarization or regional currency, 1999)." The reason for social inequality in Latin America has as much to do with their culture as with any economic mismanagement. Though less so now than in the past, Latin American society functions on the remnants of a patron system. The trade off, for Latinos, in buying into dollarization is that they loose one patron, but gain another, who is farther away, and cares less about their problems, generally (Rojas, 1984).
Map of Ecuador
Who is Ecuador?

What view a person holds on the issue of dollarization all comes down to a question of how people define themselves. Is stability worth giving up sovereignty? What about cultural identity? At a university commencement address in 1982, Carlos Fuentes gave an accurate summary of the Latin perspective: "Nationalism represents...a profound value for Latin Americans simply because of the fact that our nationhood is still in question. In New York, Paris, or London, no one loses sleep asking himself whether the nation exists. In Latin America you can wake up and find that the nation is no longer there...(Davis, 1987)." Latin Americans desperately feel the need to constantly reaffirm who they are as a people. The new globalization move, and its implied monocultural movement, will only make them hold tighter to their culture. The fact that this monoculture is rooted in the same society that has held such a strong hold over Latin America for roughly a century only increases that cultural tenacity. It is no wonder, then, that when the Ecuadorian president announced that he would pursue dollarization, that is, basing the Ecuadorian monetary system on US currency, that native groups organized and executed a political coup.

Still, the fact that countries such as Argentina, Venezuela, Guatemala, Ecuador and Mexico are approaching the idea proves that their culture is changing, and the vitality of their economies is taking an increasing precedence (Goldman, 1999). This is an important point to keep in mind.

Once a country decides that it will dollarize, it must decide how it will dollarize. The three options are overnight dollarization, using a transitional period, or parallel dollarization. All of which have downfalls.

An overnight dollarization, in which there is no transition period, would wreak havoc on the whole world's economies, since they are so intricately connected. Not only would the dollarized economy feel the effects, but so would all the governments, businesses and financial institutions which hold sucres, for example. Such an action would result in massive, instantaneous shifts of currency across borders. An overnight dollarization is highly unlikely, however, since the processes involved are so complicated, and require such a high degree of planning, that it would be impossible to institute in one day.
Interconnection of World Markets
In changing currency, a country must keep in mind how tightly integrated the world economies are.

Announcing a transitional period is problematic in countries experiencing a currency crisis. The theory is that people would "run for cover" and the "unofficial exchange rate of the domestic currency would plunge whil[e] interest rates rocket (Shu-ki, 1998). However, this method of dollarization gives the local economy time to adjust and foreign economies the time to plan and implement reactive policies.

Parallel dollarization means that a country accepts US currency alongside its own, without saying when or if it will eliminate the local currency. This still holds the problem of capital flight, falling exchange rates, and rising interest rates. With this system, though, the process is more open to a natural dollarization, where individuals decide whether they would rather hold a dollar or a sucre. Eventually, the local one disappears by itself, especially since the local currency exchange rate continues to fall. Argentina's parallel dollarization is a little more regulated, though. Instead of operating with no particular deadline, they pegged their currency (Shu-ki, 1998). This means that the Argentine peso is equivalent to the dollar in value, which Argentina maintains through strict monetary policy. However, they essentially eliminate their currency through age and monetary policy. For example, when money gets old, national treasuries buy the currency, burn it, and reimburse the owner in new currency. The owner can choose what currency they want. The peso would get harder to find, though, since Argentina will only print new pesos if they have US dollars to back them up. A peso is only worth a dollar, so what is the difference in which you hold? Only that the US Dollar is not a reactive currency.

Ecuador is taking the transitional route with a semi-parallel approach. Over the next few months, the central bank will buy up the sucres in circulation and replace them with US dollars. There are roughly US $450 million sucres in circulation, and $1.2 billion dollars in Ecuadorean foreign reserves, so the government does not foresee a problem converting currency. This does not take savings accounts, most of which were frozen since March 1999, into consideration, nor checking accounts. The government plans to deal with that problem by issuing dollar-denominated bonds for accounts over US $4,000, or delaying cash compensation for another year. The sucre will only continue to exist in small transactions in the form of coins, similar to the system they use in Panama. The sucre would be equivalent to its US counterpart (Rohter, 2000). If Panamanian balboa is any indication of what will happen to the sucre, then it is destined to disappear completely, except for bank vaults. Any interested currency collectors or tourists will have to go there, if they wish to take home this piece of Ecuador, just as they have to do in Panama. The local currency is allowed to circulate, but US currency will take over.

3. Related Cases

4. Draft Author:

Scales of Justice Scales of Justice

II. Legal Clusters

5. Discourse and Status:

Disagreement and Allegation. Basically, only three Latin American countries are dollarized. So far, none have approached the United States about a fiscal agreement in regards to adopting the dollar.

6. Forum and Scope:

The United States and Ecuador.
Money changers in Quito streets
Dollars were commonly changed for sucres on the streets of Quito, even before dollarization

The primary parties involved are the United States and the other countries within the Americas. Although other Asian countries, such as Singapore, have considered dollarization, the countries that have actually implemented it are in the Western Hemisphere. Currently, Panama, Ecuador and Argentina have monetary policies which officially tie their economies to the US dollar.

The Federal Reserve estimate that two-thirds of the $580 billion in circulation, is outside the United States. According to one World Bank official,

7. Decision Breadth:


Dollarization has a history of controversy. Panama dollarized in 1904, at its independence. It did not seem to have much of a choice, though, considering that the United States basically "liberated" the country for the sake of building the Panama Canal. They did not like the Colombian price. The US did eventually pay Columbia.

The most recent instances of dollarization occurred in Argentina and Ecuador. Both instances were surrounded with controversy. In Ecuador, for example, the president mentioned it, then was overthrown by a coup of indigenous people. The vice president then rallied military support and overthrew the coup in a junta. The Ecuadorian economy dollarized on March 8 this year.

8. Legal Standing:


One of the international agreements influencing the flow of money is the Financial Services Annex of the WTO Uruguay Round; an agreement that includes more than 95 percent of world trade in banking, insurance, securities and financial information. Negotiations for this agreement ended on December 12, 1997, with 70 members agreeing to open their financial sectors (Financial Services, 1997). Seventeen of the signatories were American countries, including Bolivia, Brazil, Canada, Chile, Colombia, Costa Rica, the Dominican Republic, Ecuador, El Salvador, Honduras, Jamaica, Mexico, Nicaragua, Peru, the United States, Uruguay and Venezuela. Governments had until January 29, 1999 to accept the agreement.

The Financial Services Annex of the WTO’s Uruguay Round states that governments have the right to take “prudential measures” to maintain the integrity and stability of their financial systems. This includes taking measures to protect investors, depositors, and insurance policy holders, but excludes governments exercising authority over their financial systems. What does this mean in the context of dollarization? It means that a non-US government has the right to dollarize in order to stabilize its economy. It also says that this government lacks the right to influence the US financial system. In other words, the dollarized economy is dependent on a system outside of its government’s control. While such a government could try to influence the US Central Bank to print more dollars, or at least not buy them off the market, that foreign body has no legal right to force compliance (WTO’s Financial Services Negotiations, 1997).

Table 2 - Fiscal Year 1997

Denomination Notes Printed
Coin Number Minted

This leads to yet another problem, which is one of an actual restriction of trade. The US only prints a limited amount of money and each bank must retain a certain amount in reserve. The US government thinks of how much money it needs to ensure a strong national economy. It thinks little of other governments which may depend on the dollar. Under the General Agreement on Trade in Services (GATS), countries are not allowed to restrict the flow of money transferred out of the country for services supplied (Non-tariff barriers, 1998). A dollarized government has to though if there is a shortage of US currency to back their local currency, which means that they cannot print any more money. The amount of Argentine currency, for example, would depend on how much they can acquire. This would limit the amount of currency that can flow out of the country. The situation is exacerbated by one unforeseen complication. If the other American states begin to dollarize, without first reaching some policy agreement with the US Federal Reserve, they will artificially drive up the value of the US dollar due to increased demand for it. This will actually hurt the US economy and send ripples throughout the world.

Another conflict lies with the Agreement on Trade-Related Investment Measures (TRIMS). This agreement bans any measure that might restrict or distort trade, or discriminate against foreigners or foreign products (Non-tariff barriers, 1998). A dollarized government might wish to increase the dollar inflow by requiring that foreign companies pay tax or any FDI in US currency. This would make operations a little more difficult. (it is also unlikely, since it is bad for business)

If we treat the US dollar as a product, then it is subject to the same laws, such as the Agreement on Technical Barriers to Trade. Governments and Banks certainly trade currency. This agreement states that a country cannot treat one country’s products more favorably than those of another. In this case, though, dollarized economies would at times seek US currency and treat it more favorably than it would of any other country, especially if the Fed decides to control US inflation through purchase of dollars (Agreement on Technical Barriers to Trade, 1999). The WTO evaluates all such conflicts as these in light of a country’s “wider economic and developmental needs, their policies and objectives, and the external economic environment that they face.” The dollarized situation might excuse exclusive practices in the eyes of the WTO. It might not.

The WTO examines members of the EU as one economic unit, which they are (Trade Policy Reviews, 1997). If the Americas allied, they too would become one economic unit. Are these other American states willing to sit under the same scrutiny as the US on government policies? What is the cost-benefit analysis? A government might gain financial stability through this tie, but it would also give up some of the freedom to develop that LDCs value so highly.

South America on the Globe Central American on the Globe

III. Geographic Clusters

9. Geographic Locations

    a. Geographic Domain: Many. Currently Regional, within the Western Hemisphere

    b. Geographic Site: Many. Currently Regional, within the Western Hemisphere

    c. Geographic Impact: The United States. Currently the United States, Panama, Ecuador and Argentina, but Canada, Mexico, Chile, Brazil, and Columbia are also considering the move. Since all of the currency markets affect each other in some way, though, a hemispheric dollarization would impact the whole world.

10. Sub-National Factors:


11. Type of Habitat:


world trade issue map world trade issue map

IV. Trade Clusters

The main groups that participate in the flow of money in this case are international organizations, organized crime, international and transnational banks and businesses, and individuals. The international financial institutions concerned with currency flow include: International Monetary Fund, World Bank, Bank for International Settlements , and the Organization for Economic Co-operation and Development. The international regulatory and supervisory groups include: Basel Committee on Banking Supervision (and the Financial Stability Forum beneath them), International Organization of Securities Commissions, and the International Association of Insurance Supervisors. As far as the top country financial interests in the world, that would include the Australia, Canada, France, Germany, Hong Kong, Italy, Japan, Netherlands, Singapore, United Kingdom, United States. The only top 10 banks in the world are divided primarily between two economic bodies, with seven in Europe and three in Japan.

12. Type of Measure:


Trade measures relating to the flow of money are difficult to define. The nearest one can get is trade measures relating to banks or money laundering. US Congressman Jim Leach, R-Iowa, chairman of the House Banking Committee, estimates that about $500 billion are laundered internationally, annually and that organized crime is continually devising new methods of laundering earnings from their illegal activities (Mitchell, 1998). All other trade measures would only indirectly affect the flow of money where it enters through transactions involving the sale or purchase of goods and services.

Determining the key exporter in this case is a little difficult, since the trade product in question is currency. There are several means of transferring currency across borders. Governments can tax US interests in US dollars. The Argentine Companies’ Law allows the Argentine government to tax the income on net profits of foreign business’ branches or their Sociedad Anonima at a rate of 33 percent. They also tax investment vehicles. This law also requires that company capital be registered from and denominated in Argentine currency. The Argentine Central Bank holds discretionary authority to authorize the operation, merger and transfer of the banking business of financial institutions, as well as the establishment of branches and representative offices of foreign banks.

Table 1

Argentina Ecuador
Net private capital flows $19,834m$829m
FDI $6,645m$577m
Portfolio investment flows in bonds $9,015m$136m
Portfolio investments in equity $2,236m$0
Bank and trade-related lending $1,939m$387m

which replaces Ecuador’s currency with the US dollar, at a replacement rate of 25,000 sucres per dollar. The IMF, WB, Inter-American Development Bank and the Andean Development Corporation responded by promising a $2b joint loan package over three years, to be dispersed upon Ecuadorian Congressional dollarization approval.

13. Direct v. Indirect Impacts:


14. Relation of Trade Measure to Environmental Impact

    a. Directly Related to Product: No

    The direct physical environmental impact of dollarizing would not be severe. Whether a country's financial or monetary system is based on the dollar, the peso or the sucre, the hard currency requires the same substances. Paper currency requires paper from trees, coins require metals, which must be mined. There is also the energy for the production of it, and the fuel for the ships, trains, or planes that transport it. Even if the money is electronically wired, many believe that the shuttle which takes the satellite into orbit causes a tremendous amount of atmospheric damage. NASA refutes this claim, though, saying that the emission levels are negligible in comparison to other pollution sources (Leech, 1995).

    b. Indirectly Related to Product: Yes, Dollar.

    This depends on what countries or individuals are willing to do for money. On the negative side, countries might further submit their environments to degradation in order to draw industry and gain US currency. Positive aspects would come from negotiations between dollarizing economies and the US government for consideration in the formulation of fiscal policy. Such negotiations could lead to agreements that include environmentally friendly measures.

    c. Not Related to Product: No

    d. Related to Process: Yes, Finance.

    As part of an increasing move towards sustainable finance, countries are considering what alternatives to traditional foreign aid might be out there. One such option they have considered, which would directly impact a dollarized economy, is to tax the actual foreign exchange transactions. Such a move would only supply another reason for the Americas to adopt an Amero currency (European Centre for Development Policy Management, 2000).

15. Trade Product Identification:

The US Dollar, cash and coinage

16. Economic Data

17. Impact of Trade Restriction:

18. Industry Sector:


19. Exporters and Importers:

USA and Many.

V. Environment Clusters

20. Environmental Problem Type:


21. Name, Type, and Diversity of Species


22. Resource Impact and Effect:

Only trees for paper and mining for metal.

Table 3-Coins

Type of Metal Copper Zinc Nickel
Penny 95% 9% -
Nickel 75% - 25%
Dime 75%clad, 100%content - 25%clad
Quarter 75%clad, 100%content - 25%clad
Half-Dollar 75%clad, 100%content - 25%clad
Dollar Coin 75%clad, 100%content - 25%clad

23. Urgency and Lifetime:

Low and unknown.

Some economists believe that full Dollarization or the "Amero" associated with a Free Trade Agreement of the Americas will not happen for 5-20 years.

24. Substitutes:

Alternatives to Currency.

The discussion of Dollarization is moot, if credit predictions are accurate. Some believe that the future of commerce lies in electronic currency. Of course, that is a problem for the currently "unwired" developing world.

VI. Other Factors

25. Culture:

The United Nations Educational, Scientific and Cultural Organization (UNESCO) adopted the Convention concerning the Protection of the World Cultural and Natural Heritage in 1972. The World Heritage Committee oversees this convention. Their mission statement includes the goals:

Currently, this convention does not include currency as cultural heritage, though it is an important part (Mission Statement, 1996). For example, when a person thinks of the US, many items come to mind, including the US dollar. That is because it is a part of the US culture. Currency represents not only a means of exchange, but also what that state’s citizens hold dear. Cash and coin portray heroes, leaders and other national symbols. The physical boundaries between countries and cultures are now blurred. Just as the clash of cultures now extends to items, such as Pisco or Feta, the definition of what qualifies as cultural heritage also extends. As the WTO debates who owns Champagne, and the EU fights about what qualifies as chocolate, perhaps UNESCO should consider the cultural content of currency.

26. Trans-Boundary Issues:


27. Rights:


28. Relevant Literature

Agreement on Technical Barriers to Trade. (1999, August 13). World Trade Organization. http://www.wto.org/wto/legal/finalact.htm#TRIPs (2000, April 9).

Antonio Jose de Sucre. (2000). Archipielago. [On-Line]. Available: http://archipielago.org/sucre.htm (2000, May 8).

Calvo, Guillermo. (2000, April 14). Capital markets and the exchange rate with special reference to the dollarization debate in Latin America. [On-Line]. http://www.bsos.umd.edu/econ/ciecalvo.htm (2000, April 17).

CNNfn. (1999, April 22). Dollarizing ok: Fed chief. [On-Line]. http://cnnfn.com/1999/04/22/economy/greenspan (2000, April 17).

Davis, R. (1987, Spring). The odyssey of identity: Culture and politics in the evolution of Latin American nationalism. Platte Valley Review, 15 (1), 36-45.

European Centre for Development Policy Management. (2000, February 22). 10th Anniversary Seminar on Alternatives to Cooperation: Sustainable Finance as an End to Development. http://www.oneworld.org/ecdpm/en/events/97005/ (2000, April 17).

Experts discuss pros and cons of dollarization. (1999, July 26). Honduras This Week: On Line Edition. http://www.marrder.com/htw/jul99/business.htm (2000, March 7).

Financial Services. (1997, February 2). World Trade Organization. [On-Line]. http://www.wto.org/wto/about/agmnts5.htm (2000, April 9).

Goldman, M. (1999, July 26). Will the greenback reign? A growing contingent says an Americas dollar is inevitable, but who will benefit? [On-Line]. http://cnnfn.com/1999/07/26/worldbiz/dollarization/index.htm (2000, April 18).

Hirst, P. & Thompson, G. Globalization in question. (1996). Malden, MA: Polity.

Inclan, I. (1999, August-September). Dollarization or regional currency. FOB Magazine. http://www.fobmag.com/aug99/english/art8e.html (2000, February 8).

Leech, J. (1995, June 15). Controversial questions. The Kennedy Space Center. http://www.ksc.nasa.gov/facts/faq10.html (2000, April 17).

Mission Statement. (1996, October 19). World Heritage. http://www.unesco.org/whc/nwhc/pages/doc/main.htm (2000, April 11).

Mitcell, C. (1998, August 19). Effects of U.S. Money-Laundering Laws Abroad. New York Law Journal. (2000, March 27).

Non-tariff Barriers-Technicalities, red tape, etc. (1998, February 5). World Trade Organization. http://www.wto.org/wto/about/agmnts8.htm#investment (2000, April 9).

Rohter, L. (2000, January 16). Ecuador prepares for Indian protests. The New York Times. [On-Line]. Available: http://www.nytimes.com/library/world/americas/011600ecuador-econ.html (2000, May 8).

Rohter, L. (2000, January 12). Ecuador's 3 top central bankers quit over dollarization. The New York Times. [On-Line]. Available: http://www.nytimes.com/library/world/americas/011200ecuador-econ.html (2000, May 8).

Rohter, L. (2000, January 11). Foes fight Ecuador's leader on dollar plan. The New York Times. [On-Line]. Available: http://www.nytimes.com/library/world/americas/011100ecuador-politics.html (2000, May 8).

Rohter, L. (2000, January 18). In Ecuador, using the dollar to hold the line. The New York Times. [On-Line]. Available: http://www.nytimes.com/library/world/americas/011800ecuador-us-dollar.html (2000, May 8).

Rojas, R. (1984). The role of U.S. imperialism in Latin America. The Robinson Rojas Archive. http://www.rrojasdatabank.org/foh4.htm (2000, March 7).

Savings in dollars growing. (1999, July 26). Honduras This Week: On Line Edition. http://www.marrder.com/htw/jul99/business.htm (2000, March 7).

Shu-Ki, T. (1998, October 26). A critical comment on government-sponsored dollarization as a rescue. [On-Line]. Available: http://www.hkbu.edu.hk/~econ/web9812.html (2000, May 8).

Trade Policy Reviews: Ensuring Transparency. (1997, January 15). World Trade Organization. http://www.wto.org/wto/about/agmnts10.htm (2000, April 9).

WTO’s Financial Services Negotiations. (1997, December 15). World Trade Organization. http://www.wto.org/wto/services/press86.htm (2000, April 9).

29. Image Reference

Altavista Homepage. (2000). [On-Line]. Available: http://www.altavista.com/cgi-bin/query?mmdo=16&stype=simage (April 4, 2000)

CNNfn. (1999, April 22). Dollarizing ok: Fed chief. [On-Line]. http://cnnfn.com/1999/04/22/economy/greenspan (2000, April 17).

Corbis pictures. (2000) [On-Line]. Available: http://search.corbis.com/default.asp?i=10235343&vID=101 (2000, May 9).

Corbis pictures. (2000) [On-Line]. Available: http://search.corbis.com/default.asp?i=11443565&vID=1&rID=101 (2000, May 9).

Corbis pictures. (2000) [On-Line]. Available: http://search.corbis.com/default.asp?i=11427947&vID=1&rID=101 (2000, May 9).

Domestic coinage produced by the United States Mint: Fiscal year 1997. (1998, November 6). Department of the Treasury learning vault. [On-Line]. Available: http://www.ustreas.gov/opc/opc0062.html (2000, May 8).

Free Trade Area of the Americas homepage. (2000). [On-Line]. Available: http://www.ftaa-alca.org/alca_e.asp (2000, May 8).

Krempel, L. (1992). A gallery of social structures: Structures of world trade. [On-Line]. Available: http://www.mpi-fg-koeln.mpg.de/~lk/netvis/trade/WorldTrade.html (2000, May 9).

The manufacturing process for United States coins. (1998, January 8). Department of the Treasury learning vault. [On-Line]. Available: http://www.ustreas.gov/opc/opc0071.html (2000, May 8).

The New York Times. (2000, January 18). [On-Line]. Available: http://www.nytimes.com/library/world/americas/011800ecuador-us-dollar.html (2000, May 8).

Spanish Language Immersion Programs in Ecuador. (1998). Spanish abroad, Inc. [On-Line]. Available: http://spanishabroad.com/ecuador.htm (2000, May 9).

Trade and Environment Database. (2000, April). [On-Line]. Available: http://www.american.edu/projects/mandala/TED/hp1.htm (April 4, 2000).

United States paper currency production statistics. (1998, October 22). Department of the Treasury learning vault. [On-Line]. Available: http://www.ustreas.gov/opc/opc0065.html (2000, May 8).

*Refer to the Panama paper.

*A classic basic philosophy/theology question is "which came first, the chicken or the egg?" One must assume that one came first. Is it the egg? How does it hatch itself? Did the chicken come first? Where did it come from? Such is the question of whether fiscal discipline is a prerequisite or a symptom of a dollarized economy.

E-mail your 
comments and suggestions to me.

*This paper submitted for
Computer applications in International Relations research, SIS 513
Professor: Dr. James Lee.


Make your suggestions, then click submit.