Dollarization: A Common Currency for the Americas?
March 6–7, 2000
Federal Reserve Bank of Dallas

A year ago we began debating in Argentina the plausibility of adopting a strategy to dollarize our economy. This discussion reflects our understanding of the importance of grasping the main and determining features of globalization. This is central to be able to benefit from the opportunities that globalization generates for our countries.

Today, the countries of this region (the American continent) have included dollarization and the creation of a single continental currency in their policy agendas. In addition, the International Monetary Fund (IMF) has recently released a study that addresses this subject and focuses particularly on the Argentine case.

Our proposal in early 1999 to adopt the U.S. dollar as our currency was launched in a context of an international financial crisis (the most severe one since 1929), whose origin goes back to South East Asia in 1997. Combined with the devaluation of the Brazilian real, this crisis threatened to put our monetary stability at risk.

In this context, the initiative to introduce dollarization sent a signal to financial markets that there was a firm political will in the Argentine government to avoid currency devaluation. The markets interpreted the message correctly. In fact, the dollarization proposal was a decisive factor that prevented a rise in the country risk rate, a probable capital flight and the potentially detrimental from the Brazilian crisis. Similarly, the confidence that was gained by this initiative contributed, at least in principle, to eliminating a problem that the Convertibility Plan could not resolve: the cost of capital.

The persistence of a difference between the interest rate in pesos and the interest rate in dollars indicates that, in spite of the monetary stability secured by the convertibility law, the financial markets continue to perceive a potential risk of currency devaluation in Argentina. This perception accounts for the high-risk rating given to Argentina, which, in turn, is reflected in the high cost capital.

The international crisis that originated in July 1997 exposes the deep transformation process of the world economy that has modified the nature of capitalist accumulation. This transformation is the result of three convergent factors.

First, the world economy has entered a new phase characterized by monetary globalization. This phase is preceded by two previous phases: the transnationalization of production during the 1990s and the intensification of monetary globalization during the 1980s. At present, the process of capitalist accumulation has reached an increasingly global dimension. The global scale of accumulation demands a type of currency that best reflects its global nature. Global currencies are therefore the best reflection of this process of the world economy globalization.

Second, the increasingly higher and sustained productivity registered by the U.S. economy has a direct impact on the world economy. By raising the productivity "floors" of the world economy, the U.S. economy drives all other economies to increase their economies' productivity in order to be or remain competitive.

Third, the rate of productivity-level increase of the U.S. economy shortens the time required for restructuring all the world economy processes. The adaptation to the rhythm imposed by world economy cannot be avoided.

The World Economy
In the context of increasing globalization of the world economy, capital flows transcend national borders. National currencies tend to be inconsistent with these capital flows that do not recognize borders.

There have been cases in which national currencies were responsible for inflationary crises, extreme uncertainty and instability. The consequence of such crises has been the intensification of the predominance of global currencies. Events have shown that the dollar has become a truly global currency, sustained by the power and productivity levels of the United States.

The dollar's global character is reflected by the fact that 65 percent of central banks' total currency reserves are in this currency. Since 1993 at least 55 percent of the reserves have been in dollars. Moreover, the dollar is the most-employed world currency in international transactions: approximately 83 percent in dollars, 37 percent in German marks and 24 percent in yen. Similarly, the proportion of industrial countries' exports in different currencies reveals that 50 percent of exports are conducted in dollars, 25 percent in marks, and less than 10 percent in pound sterling, francs and yen. According to estimates of the U.S. Federal Reserve, there are currently $480 billion in circulation. Moreover, $300 billion of this total circulate outside the United States. Finally, in 1996 nearly 75 percent of external bonds were issued in dollars. These figures show the extent to which the dollar has become a global currency.

Governance
The uncertainty generated by international crisis triggered a drastic redirection of capital flows to the U.S. market in search of security and stability. However secure, the rents obtained from this market are less profitable. Consequently, as the crisis is overcome, capital investments will again seek higher profit opportunities. In order to avoid a "return to the past," emerging markets must offer better conditions for long-term stability and attractive conditions for profit.

These conditions are directly related to the existence of solid fiscal and monetary institutions, and policies compatible with the world economy. That is, countries that obstruct or interrupt the prevailing trends of the world economy are putting at risk their capacity to reach productivity levels of the U.S. economy or at least be somewhat similar.

In addition to solid fiscal and monetary institutions, political institutions also play an important role in generating stabile conditions for investments. The certainty and security provided by political institutions is of central importance for the functioning of the economy. By stimulating innovation, political institutions help facilitate and secure investments of capital, information and technology.

Currency also plays a central role in the possibility of linking countries to the global economy. In this sense, currency acquires an increasingly political dimension. This is not just a question of monetary stability or unit of account; rather, currency serves as a means of immediate global standardization that facilitates transactions and also eliminates distortions, and lack of transparency with respect to productivity levels.

Argentina has demonstrated that it has the governing capacities to sustain the solidity of its financial and monetary system in the midst of the worst crisis of the capitalist system since World War II. This political competence is now reflected in the stability of the country's banking system as well as in its fiscal and monetary institutions. The Argentina's success in this respect reveals to what extent the fiscal and monetary solidity has been a central feature of the country's governance capacity in times of crisis.

During the 1980s, governance in Latin America was identified with its institutional dimension as a result of democratization in the region. In the present international conditions, governance primarily involves the capacity to control the fiscal and monetary variables of a country. This constitutes the main challenge for the Latin American democracies.

The way to dollarization is, therefore, the main political instrument to consolidate the governance capacities of our countries in a historical period characterized by increasingly rapid changes.

The Argentine Experience
Argentina's political and economic experience during the '90s can be best characterized as a process in which the country decreased its levels of uncertainty and reconstructed its capacity for effective policy implementation.

The implementation of the Convertibility Plan in April 1991 permitted Argentina to secure the stability and certainty of its political–institutional system. The reconstruction of political power and the recuperation of the country's credibility in the eyes of local and international financial investors constitute the key to the economic growth and increase of productivity registered in Argentina during the 1990s.

Similarly, the circulation of U.S. dollars in the Argentine economy has also been an equally important factor in the successful Argentine experience. According to the IMF, a country whose financial system more than 30 percent of its deposits in dollars must be considered a dollarized country. In such terms, Argentina is already a dollarized country.

Argentina's bank deposits, certificates of deposit and other banking documents are signed in dollars. Moreover, 66 percent of the total bank loans in the country are in dollars, whereas 61 percent of the real estate loans are also in this currency. Finally, 92 percent of Argentina's public debt and 85 percent of the debt of all economic sectors are also in U.S. dollars.

At a world scale, Latin America and Russia are the regions with the greatest concentrations of dollars in circulation. Recent estimates reveal there are currently $40 billion in circulation in Russia. With a population of 150 million people, dollars per capita ratio is 266. In Argentina, approximately $20 billion are in circulation.With a population of 36 million,. the resulting ratio in our case is $555 per capita. Therefore, it could be said that, besides the United States, Argentina is proportionally the most dollarized country in the world.

Based on these considerations, the implementation of a dollarization strategy in Argentina would not represent anything different from what the current convertibility currency board system means. Indeed, as a new stage of reforms of the Argentine economy, the dollarization strategy aims at the optimization and further deepening of the convertibility system.

Argentina has undertaken a series of structural reforms that enabled the country to recover its capacity for economic and institutional recovery throughout the '90s. Argentina's GDP between 1990 and 1998 increased at a cumulative rate of 43.7 percent, whereas its exports registered a cumulative increase of 83 percent.

Unlike the experience following the 1994 devaluation of the Mexican peso, during the crisis between 1997 and 1999 Argentina was not affected by capital outflows from its bank deposits. On the contrary, the deposits in the financial system were increased and the amount of foreign direct investment (FDI) remained stable. In midst of the September 1998 crisis, the deposits amounted to $2 billion.

By the second half of 1999, the reserves of the Central Bank of Argentina (BCRA) were $32 billion (the largest amount since the beginning of the convertibility plan in 1991). Similarly, the deposits in the financial system in both pesos and dollars were over 75 billion, the highest point in the past 50 years.

Moreover, foreign direct investment in Argentina increased during the crisis that began in July 1997. Proportionally, considering the relation between population and GDP, Argentina was the first receptor of FDI during the past two years.

A strong political leadership permitted Argentina to shape its new institutional and economic reality in a difficult international context of acute crises: the hyperinflation of 1989–90 and the effects of the 1994 Mexican devaluation. Strategic decisions were crucial for establishing a framework of stability that permitted Argentina to regain its international reputation.

Since the financial crisis that began in July 1997, foreign direct investment increased. Compared with countries comparable in population and GDP, Argentina has been the longest receiver of FDI in the world for the last two years.

Foreign investors have learned to differentiate between stable and unstable emerging countries. The way countries reposition themselves in new scenarios depends on how they manage to face and overcome crises. Argentina has managed to maintain and consolidate its fiscal and monetary system. Also, the rate of its economic growth was double that of the world economy's average growth rate. These conditions put Argentina in a favorable position for receiving foreign direct investments. Argentina's economic outlook for 2000 is excellent.

According to the IMF, the dollarization of the Argentine economy would reduce the country risk rate by approximately 50 percent. Similarly, Argentina has the capacity to become one of the most advanced world economy. In addition to its solid fiscal and monetary institutions, the comparative advantages of its natural resources can be transformed in competitive advantages through the technological innovation of the country's agroindustry. The country's high level of education and skilled labor force are vital conditions for the assimilation of new technologies and innovation.

These are the conditions on which Argentina stands to propose the dollarization initiative and monetary association with the United States. In turn, these conditions help generate a stable macroeconomic framework in accordance with the parameters of stability established by the Maastricht Treaty.

Certainly, dollarization is by no means a magical solution to all problems. Yet, it can serve as a means of initiating reforms.

Some opponents to the dollarization proposal argue that this option entails loosing the country's right to seigniorage. However, a recent bill presented by the Senator Connie Mack (Florida) proposes that the United States share up to 85 percent of its seigniorage with those countries that have decided to dollarize their economy.

Senator Mack's initiative reveals that dollarization is not limited to the national interest of Argentina and other Latin American countries alone. Dollarization also concerns the United States' national interest. NAFTA has opened the American hemisphere to increased trade and investments from the United States. The creation of a free trade area in the hemisphere will intensify this trend. Dollarization will thus increase the structural links between the economies from North to South.

In a time of rapid change, the role of statesmen and political leaders is not to wait for events to happen but to go forward in anticipation of the future. Financial globalization is already a structural feature of the world economy, and dollarization is a direct consequence of this globalization in the American hemisphere.

The moment to act has arrived. It is time to put ourselves to work.