OUTSOURCING isn't just a one-way street on which rich countries shift jobs
overseas. In recent years, some developing countries have contracted out the
work of setting monetary policy to the United States. Ecuador and El Salvador,
in 2000 and 2001, respectively, abandoned their own currencies, adopted the
dollar and placed their monetary policy in the capable hands of Alan Greenspan, then the chairman of the Federal
Reserve.
When outsourcing involves manufacturing and software programming it is often
endorsed by economists and condemned by populist political leaders. So, too, is
the tactic of outsourcing of monetary policy known as dollarization, or
euro-ization. After all, noted Robert E. Litan, senior fellow at the Brookings
Institute, "currencies are symbols of national sovereignty, and countries are
reluctant to give them up."
And yet nations can impose enormous costs on their citizens when they take
extraordinary efforts to maintain independent currencies. "Devaluations of
currencies cost people their savings and bring on rapid inflation," said Benn
Steil, a senior fellow at the Council on Foreign Relations and co-author with
Mr. Litan of "Financial Statecraft" (Yale University Press, 2006). The two argue
that the globe's mélange of 200-plus currencies, backed only by the faith of
investors, is inefficient and dangerous. Many emerging economies, they say,
would be well advised to swap their currencies for strong, stable, widely used
ones like the dollar or euro.
Steve H. Hanke, professor of applied economics at Johns Hopkins University,
has examined economic development in 32 countries that adopted foreign
currencies from 1950 and 1993. He found that they had faster rates of G.D.P.
growth, lower inflation and greater fiscal discipline than their counterparts
who hung onto their sovereign currencies. Professor Hanke has been an adviser to
Ecuador, which in 2004 was among the best-performing economies in Latin America,
growing at a 6.6 percent rate with inflation at 2.7 percent.
"Dollarization tends to deliver low inflation, and relatively low and stable
interest rates," said Ricardo Hausman, a former chief economist of the
Inter-American Development Bank who now teaches at the Kennedy School of
Government at Harvard.
So what's not to like? "It's not like dollarization is a magic drug," Mr.
Steil said. It certainly doesn't end the risk that countries will default on
dollar-denominated debt. Panama has been using the dollar since 1904 and has
repeatedly run into difficulties. And El Salvador's economic performance hasn't
outpaced those of its Central American neighbors.
Some Latin American countries, notably Mexico, have tamed inflation without
abandoning their own currencies. "If you have sound economic policies in a
country, you don't need dollarization," said Nouriel Roubini, professor of
economics at New York University's Stern School of Business. "And if you follow
poor policies, I don't think dollarization will solve your problems."
But economists say that smaller countries can encourage investment by lashing
their monetary fortunes to larger regional powers. In Latin America, companies
that need to make long-term investments like utilities are forced to borrow
in dollars while they operate in local currencies, leaving them exposed to
currency risk. Now that El Salvador has adopted the dollar, companies there can
borrow or engage in hedging transactions in dollars with relative ease.
And when small monetary boats tie themselves together or link themselves to
larger ones, it encourages stability. "European financial markets were able to
navigate problems of 9/11 and the Madrid and London bombings without too much
instability, because they didn't have the extra layer of exchange-rate
problems," said Barry Eichengreen, professor of economics and political science
at the University of California, Berkeley.
But one economist's reassuring stability can be another's troubling rigidity.
If the price of coffee plummets or the price for textiles falls because of
competition from China, a Latin American country that has dollarized won't have
the option of cutting interest rates to stimulate growth. "Dollarization takes
away the option of depreciation," Professor Hausman said.
Dollarization advocates say that this is all to the good. Mr. Steil notes
that the Dominican Republic, where a currency crisis in 2004 wiped out the
savings of a significant chunk of the population, conducts about 85 percent of
its trade with the United States. "Why on earth would they need their own
currency?" he asks.
Large countries like the United States have to tread lightly in advocating
that small countries give up their currencies. In 2000, Congress considered
but did not pass the International Monetary Stability Act, which would have
provided financial assistance to countries that adopted the dollar.
WHAT'S more, moving to unite monetary policies without integrating political
and labor systems is problematic. The 12 member nations of the euro zone have
solved the political problems created by common currencies by adopting a
transnational institutionthe European Central Bank and giving every country a
seat at the table, Professor Eichengreen said. "Where is Ecuador's seat on the
Federal Reserve Board?" he asked.
Advocates of dollarization recognize that the trend is also at odds with the
prevailing political winds in the Western Hemisphere. "There is a
mini-anti-American revolt going on in Latin America as we speak," Mr. Litan
said. "Countries that would otherwise be interested, like Bolivia and Venezuela,
have elected leftist governments" that are ardently opposed to
dollarization.
But Mr. Litan says he believes that time may be on the side of the dollar:
"History has marched toward the euro, and it is slowly marching toward the
dollar."
Daniel Gross writes the "Moneybox" column for
Slate.com.