Re: Dollarization -- Moore's argument

[LP Rochon <lprochon@xxxxxxxx>]

Hey,

I'm back!!!

LP

Matias Vernengo wrote:

> 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