Opinion: Dollarization (part 2)

POSTED: 06/27/11 2:14 PM

In a presentation dated Feb 8 of this year entitled “Balance of payments vulnerabilities caused by a widening current account deficit: a way forward. Is dollarization the right approach?” given by Dr. E.D. Tromp, President of the Central Bank of Curacao and St. Maarten, the opening slide states: “So much of barbarism still remains in the transactions of the most civilized nations, that almost all independent countries choose to assert their nationality by having, to their own inconvenience and that of their neighbors, a peculiar currency of their own. – John Stuart Mill (1848).”

Now due to length considerations for this article, it won’t be possible for me to go into the details of the presentation but I will touch on the given reference of John Stuart Mill and also on one of Tromp’s statement in the presentation which is as follows: “However, dollarization is not a prescription to resolve structural and institutional problems which, in many cases, give rise to crisis conditions in the first place. These problems must be addressed in order for countries to achieve long-term economic stability and growth.”

What does Balance of Payments (BOP for short) mean? The following link http://en.wikipedia.org/wiki/Balance_of_payments gives a good definition but in more simplistic and broader terms it means the difference between goods and services, financial capital, and financial/money transfers we import and export. The BOP is an accounting record of all monetary transactions between a country and the rest of the world. The BOP is made up of the current account and capital account.

Our major troubles have been with the current account due to its increasing deficit position. When a country’s total imports of goods, services and (money) transfers are greater than the county’s total export of goods, services and transfers, it puts pressure on our reserves because of the net debtor position build up in relation to our trading partners. Pressure on our reserves affects our ability to maintain our guilder peg to the dollar. Our major industry that we export is tourism; meaning as we market our tourism product and we get tourists coming to the island, they in turn bring money to our island.

Until a few years ago tourism revenues were able to offset our cost of imports. So we chose the comfortable position of putting all of our eggs in developing tourism rather to make a smooth transition after the peak development of the tourist product to re-channeling funds into developing our technological and infrastructural potential as well as our human capital and potential in ways that would have allowed us to reduce our dependency on imports by a set target of say fifty percent.  BOP infers balance in that ideally each country should match their import with export flows.

Why? Because consistent imbalances can have far reaching consequences in a global environment where trade is done among each other. In other words reciprocity (mutual exchange) is a condition for globalize trade to be successful in the long term.

Now due to what seems to be a structural development in that we are giving out more than what we are receiving, and also due to the global instabilities, a plausible solution was put forth by our Central Bank president that addresses the main concern of our guilder exchange peg to the dollar. However, I don’t believe the entire picture was given in order for one to make a sound conscious decision. And I can very well understand why because I believe that the central bank’s president is of the opinion that the USD will remain the reserve currency of the world for some time.

However, I am of a different opinion considering my own research as well as understanding of the purpose for which money was created. Before I go into the specifics, there is one piece of theory, The Triffin Dilemma, which I need to bring forth and explain in order for persons to see the entire picture at hand which is broader and more complex than just a balance of payments affecting our guilder peg issue.

The Triffin’s Dilemma, identified by economist Robert Triffin, highlights a fundamental imbalance caused by a national currency acting simultaneously as a global reserve currency. Specifically it refers to the US dollar’s role under the Bretton Woods agreement. It states that the use of a national currency as global reserve currency leads to a tension between national monetary policy and global monetary policy.

Triffin noticed that the US had two competing and incompatible goals while maintaining the Bretton Woods system: If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability. If U.S. deficits continued, a steady stream of dollars would continue to fuel world economic growth. However, excessive U.S. deficits would erode confidence in the value of the U.S. dollar. Without confidence in the dollar, it would no longer be accepted as the world’s reserve currency. The fixed exchange rate system could break down, leading to instability. Obviously, the US was faced with a dilemma because it is not possible to run a balance of payments current account deficit and surplus at the same time.

Source: http://tragedy-of-the-commons.blogspot.com/2009/03/triffins-dilemma.html

 

The Triffin’s Dilemna is often called a paradox. The US confronted this dilemma first identified in 1960 by the Belgian-born Yale economist Robert Triffin. But why a dilemma or paradox? Because of the conflict between the benefits and costs of a country with a reserve currency running a large current account deficit. The reserve-currency country enjoys the consumption benefit of running a trade deficit, while the rest of the world benefits from the additional liquidity, which helps facilitate trade. The cost comes from the declining value and credibility of any currency which runs a persistent trade deficit which eventually will lead to a reluctance of creditors to hold the reserve currency. To simplify this, remember what I said in part 1 concerning supply and demand being the basic foundation of economics 101? The more there is of something while no increase in demand for such will reduce its value. On the local level, increasing the supply of ones currency reduces the value of such if no corresponding real (non speculative) local economic activity is generated (so a proportional increase in supply of goods and services) to absorb the increase. But if a country has chosen to use its local currency to be a world reserve currency, it will need to keep printing more as the demand globally increases irregardless of its national situation. Stay tuned for part 3.

Emilio Kalmera

 

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