A Case Against U.S. Dollarization

Challenge, July, 2000 by George von Furstenberg

One way of explaining the difference between unilateral and multilateral monetary union is to think of what happens when a minor national airline company gets such a bad reputation that almost all air travelers, foreign and domestic, prefer to fly on other carriers. Eventually that bankrupt airline and all its local airbusing and landing rights are sold to a foreign carrier for a penny, and good riddance.

But what if the small national airline had in fact been well run but now was unable to overcome the enormous network and code-sharing externalities that it could not enjoy as long as it remained on its own? It would then seek a timely business combination, such as a friendly merger, that did not imply being closed down and declared dead for foreign vultures. Even if the small airline were to lose its national identity through an exchange of shares in the surviving carrier, there would then be full maintenance of value and, indeed, the creation of new value, for both the acquired and acquirer, through an economically efficient merger. By contrast, if the acquirer refused a timely merger, declined to give anything of value, and instead waited until the small national carrier had gone belly-up, then one has a picture of the industrial-relations equivalent of what happens under unilateral monetary union.

Many applaud complete dollarization, the least adaptable and least giving form of monetary union, as more stable and efficient than carrying on with heavily protected, poorly maintained, and ultimately doomed mini-carriers of monetary services, particularly in South and Central America and in the Caribbean. Others would say that taking a dangerous toy away from a small country is all to the good, without acknowledging that its customer base should be worth something. By definition, Pyrrhic victories do not last, but neither do those that are completely unrestrained. On the European continent, commanders often could lay siege and starve out a free city rather than come to terms with its citizens if theirs was the only army and cavalry in the field. A few far-sighted field marshals chose the latter course, sparing the city nonetheless, and they tend to be remembered as builders of history.

Multilateral union is much kinder to small countries than joining a monetary union unilaterally, per unassisted formal dollarization. It does not expropriate their national monetary asset through annihilation and foreign replacement. Rather it transforms this asset from a national to a multinational form and makes it whole in the process. For even if a country had lost part of the domestic component of its monetary base, and hence part of its national seignorage, through currency substitution to the dominant international currency in the region, its seignorage share would be based on estimates of all of the common currency circulating within it after monetary union. The deutsche mark notes that account for 10-20 percent of Poland's currency supply, together with U.s. dollars and zloty, now still yield a flow of seignorage benefits to Germany--via interest saved on the debt that the German government otherwise would have issued. However, this foreign fraction will become part of Poland's own euros and seignor age share once Poland has joined the European Monetary Union, as well may happen in the course of this decade. In addition, the head of Poland's national bank (NBP) then will have a seat on the European Central Bank (ECB) Council, like every other member, thus acceding through a merger of equals. Financial and banking systems, once cleaned up and properly provisioned and mutually supervised, will start to mesh throughout a wider European monetary region, so that even country risk will drop sharply. Poland, incidentally, has had a per capita gross domestic product (GDP) that in 1997 was about the same as that of Mexico at the prevailing average exchange rates. Hence multilateral monetary union need not be a rich-country exclusive.