The High Price of Safety the Hidden Costs of Ditching Your National Currency for the Dollar
The High Price of "Safety": The Hidden Costs of Ditching Your National Currency for the Dollar.
Given the chaos of national currencies in the world today and the ever-changing price of a dollar, it's easy to see why the notion of just dumping a struggling national currency for the stability of the U.S. dollar is an appealing quick fix for prosperity. The term dollarization crops up from time to time in Argentina's recent discussions, through to regular transactions in Nigeria. However, the promise of this "shortcut" from economic instability appears to be the golden bullet solution, but when viewed from a different perspective, the price tag can be far greater than the value and often leaves new and greater vulnerabilities.
Does Dollarization Mean What It Says?
It's important to note that there are two types. Unofficial dollarization occurs more broadly, such as Nigeria where people use dollars to hold value or pricing goods to protect themselves against inflation and the naira's depreciation. When the Central Bank, citing Section 20 of the CBN Act, attempts to enforce the use of the naira, it's fighting against this phenomenon. This is a sign of a much bigger issue: over the last few years, there has been a lack of confidence in the local currency.
But the more radical idea is "official" dollarization. This calls for the elimination of all domestic currencies and central banks, and for the U.S. dollar to be the only legal tender. Often, it is suggested that Panama (or perhaps Ecuador or El Salvador) is a stable country.
The Double Squeeze: A Secret Economic Panic
Perhaps the most important, and most prevalent, drawback of the official dollarization is the loss of monetary sovereignty. If a country produces its own money, the central bank can print more money to serve the need for money in circulation for economic development.
There is an obvious analogy to the problem. Suppose that there is equilibrium in an economy. The economy will normally grow by 100 dollars for every 10 dollars increase in exports to maintain the external account balance. In a fully dollarized economy, though, you must have dollars flowing that new GDP, as well. If the “currency to GDP” ratio is 10 percent, to maintain a 100-dollar GDP increase, an extra 10 dollars must be added to the GDP, which can only be created by printing foreign currency. This dollar must be earned by the country or borrowed.
This is a "double squeeze" on the economy. The country now has to pay for its imports with its dollars, and also for domestic currency circulation, thus restricting its growth potential. This pressure frequently results in the imposition of austerity measures that are hard on both welfare and wages benefit recipients, such as wage reductions, pension curtailment, and welfare cuts.
Collapse of the Safety Net: Exposure to external shocks
If a country switches to the dollar, it can no longer influence its interest rates or money supply in order to adjust to local economic conditions. If the economy starts to slow down or a financial crisis arises, the nation can't do it alone to jump-start the economy.
Trinidad and Tobago is a case in point. Even though the country has a good local currency, the debate on dollarization rarely takes into consideration that each year the country loses billions it can't account for. One analyst added that “dollarization will not change the fact that we are spending USD2 billion on average annually that we don't know how to account for.” In times of external shocks, the economy would lose the capacity to reduce interest rates and boost liquidity, as it did in 2008 and 2013.
The Symbolism of Sovereignty
There's a strong psychological and political component as well as an economic one. A National currency is a strong symbol of sovereignty and national identity. It is a loss of independence for one to give it up. A discussion about the abolition of the connection between the currency of West Africa and the French treasury can be mixed with post-colonial politics. It was a BNP Paribas analysis that said, "Monetary sovereignty is not given but earned. Not replacing a currency is not the cure for systemic problems, but rather the new set of rules of the game.
Should the government impose stricter regulations on corn production? Should the government tighten corn production rules?
Official dollarization is being touted as a cure for hyperinflation and acts as a stabilizing anchor on prices with a foreign currency. Ecuador and El Salvador have stabilized their economies since they went on the dollar. Long-term success, however, isn't so predictable. Economic growth in Ecuador post-dollarization (2000-2023) has been extremely weak at 1 per capita, with lack of resilience to global shocks. It takes the fire to a halt; it doesn't ensure a bright and successful future.
In conclusion, the issue with “de-dollarization” in Africa is that citizens do not trust their currencies, and not the dollars. What the case of the Dangote refinery proves is that structural issues cannot be addressed with currency changes alone unless the "Naira-for-crude" policy is effective to ensure a stable supply of the crude. As one of the experts put it, there are no shortcuts for the Forex issue. The problem for Nigeria and other countries is not to replace the Naira but to regain investor confidence in the currency with a good policy.
Comments
Post a Comment
Good
I love this