Re: Dollarization -- Moore's argument

["Matias Vernengo" <VernengM@xxxxxxxxxxxxx>]

Dear Basil:

Thank you for your reply. I understood your point, or at least I think
so. As you said "with dollarization, one does not need any mechanism to
'reduce the current account deficit'."  That is, BoP adjustment is
automatic. However, a country can continue to run a deficit on both
current and capital account, as you suggest, only if it has reserves or
other compensatory capitals.  Otherwise, a capital account surplus is
needed to finance the deficit in the current account. Furthermore, if
there are no capital account surpluses then the country must contract
activity to reduce the current account deficit.  This is also true of
regions and states as Connecticut, to use your homely reference. The
unification in Italy for example, by forcing a common currency, meant
that the south kept persistent balance of payments deficits with the
north, and in the absence of the possibility to devalue, led to uneven
development. This can be partially offset by fiscal policy, and it would
not be a problem for Connecticut, but it is for Ecuador.

I would also like to point out the similarity of the following argument
you put forward with the conventional interpretation of the Gold
Standard. You say "so long as an economic unit or a country has, or
simply is believed to have, good future prospects, so that others are
willing to sell it things on credit, i.e. provide it with loans, it can
continue to run deficits indefinitely, and is not constrained because it
is running out of foreign exchange reserves." That is, credibility,
usually associated (not necessarily in your quote) among mainstream
authors to fiscal discipline, would lead to stabilizing capital flows.
When you look at the actual history of the Gold Standard you find out
that capital flows were destabilizing. The adjustment was done by
contraction of the deficit countries, which more often than not were
forced out of the system.

Of course capital flows may go in the right direction. However, you
should clarify what is that makes countries have good future prospects
and make them obtain the necessary credit.  My point is that
dollarization will do nothing to help attract capital, and makes things
awfully difficult if capital goes in the wrong direction.  I should say
also, that I believe that you have directed the debate on dollarization
to a neglected but crucial point, that is, the sustainability of the
BoP.  Hence, although I disagree with your benevolent view on
dollarization, I believe you raised an important point.  Thank you once
again.

All the very best,

Matias

>>05/10/01 02:30PM >>>

Matias

My point is solely that with dollarization, one does not need any
mechanism
to "reduce the current account deficit". For example CT. could be
running a
current account deficit with the rest of the US.(deficit on current
account), and also experience capital outflows (on capital account). So

what?  With a single currency (provided the single currency, e.g.
dollarization, is credible), a country like an economic unit can
continue
to run a deficit on both current and capital account, in the sense of
demanding additional consumption and capital goods, so long as another

party is willing to provide deficit financing.

Of course such deficit financing implies a deficit on capital account,
as
an accounting definition. Neither an agent nor a country can have
simultaneously a deficit on current and capital account.

I am not (yet) persuaded that dollarization is desirable, for all
countries, or for any single country. My point is simply that it
removes
the necessity of pursuing demand restriction to reduce a current
account
imbalance. So long as an economic unit or a country has, or simply is
believed to have, good future prospects, so that others are willing to
sell
it things on credit.i.e. provide it with loans, it can continue to run

deficits indefinitely, and is not constrained because it is running out
of
foreign exchange reserves.

Basil





At 11:07 AM 4/30/01 -0400, you wrote:
>precisely because country risk still exists, balance of payments
>problems
>do not disappear.  capital flows may go in the wrong direction. that
>is, a
>dollarized country with a current account deficit may face capital
>outflows.
>in the absence of the devaluation alternative, contraction would be
the
>
>only mechanism to reduce the current account deficit.  that is the
>sort
>of bp adjustment of peripheral countries during the gold standard.
>matias
>
>___________________
>Matias Vernengo, Ph.D.
>Assistant Director
>Center for Economic Policy Analysis
>New School University
>80 Fifth Avenue, 5th Floor
>New York, NY 10011
>Tel:  212-229-5901
>Fax: 212-229-5903
>
> >>> lprochon@xxxxxxxx 04/30/01 09:34AM >>>
>Dollarization may eliminate exchange rate risks, but country risk
>still
>exists and can explain why there are different interest rates in the
US
>and
>other dollarized countries.
>
>LPR
>
>Colin Danby wrote:
>
> > Three quick notes on Basil's note to Barkley.
> >
> > > When a country dollarizes, it ceases completely to have balance
of
> > payment
> > > problems vis-a-vis the US,
> >
> > Balance of payments "problems" or "imbalances" is too vague for a
>useful
> > discussion.  How exactly are these terms being used here?
> >
> > > irrespective of differences between the two
> > > economies. i.e. it becomes like Connecticut and the rest of the
> > States.
> >
> > This cannot be meant seriously.  One of the things binding
>Connecticut
> > to the rest of the US is a single banking system supported by the
>Fed,
> > and ultimately the taxing power of the U.S. government.  The Fed
>does
> > not backstop Ecuadoran banks.
> >
> > > 1.) There is the fact that all areas using the same currency
must
>have
> > a
> > > the same interest rate.
> >
> > I have already discoursed on this at length; let me just point out
>that
> > differences in risk will persist, they may even be heightened if
the
> > dollarized country's banks are susceptible to runs, as they must
be
>if a
> > country adopts a currency its central bank cannot make.  Check out
> > current interest rates in Ecuador if you want a counterexample to
>the
> > above statement.
> >
> > Best, Colin