Hidden and unknow cost of
Dollarization (gain to the US)
Dollarization and the Dail Index Plan stop hyperinflation overnight. The Daily Index Plan implements the principles
used under Dollarization, but with constant real value local currency monetary items and constant real value local currency non-monetary items implemented via daily indexation as was done with the Brazilian Real Plan in 1994.
Dollarization is a very costly, historically proven, but currently
obsolete, irrelevant and unneccessary monetary policy option during high
inflation and hyperinflation. Dollarization comes at a huge cost with some of
this cost hidden and unknown.
Cost of
Dollarization
- The entire monetary base (money supply) has to be substituted with US Dollars.
- The
Central Bank cannot implement any independent monetary policies once the
economy is Dollarized.
- The hidden
and generally unknown cost: The people of the Dollarized country continuously
loses the sovereign windfall profit of seigniorage when Dollarization
starts and every time new US Dollar bank notes are required as the
Dollarized local economy grows. This real profit continuously accrues to
the people of the United States of America (plus its multiplier effect) at
apparently no cost to them.
Only the Central Bank has the authority to print new money, precisely to
allow this windfall profit or seigniorage to accrue for the benefit of the entire
population of the country where the money is created (the United States of
America, in the case of Dollarization in US Dollars).
Example of the
cost of Dollarization
(i) Monetary
base in Iran (for example): USD 245 billion = cost of Dollarization in Iran.
(ii) Central
Bank Monetary policies given up:
- Monetary
easing used very successfully in the US, UK and Japan, but refused by Germany for Greece, Ireland and Portugal. These countries are, in priciple, dollarized in Euros.
- Interest
rate policies
- The
ability of the Central Bank to be responsible for labour policies very
similar to “full employment” policies in the country, like the Federal
Reserve Bank´s very successful labour policy responsibilities in the US
economy.
- The
complete range of other normal Central Bank discretionary monetary
policies.
(iii) Loss of Seigniorage
- the hidden cost, hardly understood by anyone.
What is seigniorage?
Definition
Seigniorage is the profit the Central Bank (country) makes from the difference
between the real value of fiat money bank notes and coins when they are added
to the money supply and the cost of printing them.
Only about 8 percent of the money supply is made up of actual bank notes
and coins in an advanced economy (based on the US money supply).
Fiat money has a decreasing real value during inflation: 7 billion plus people
use generally decreasing real value fiat money each and every day to buy and
sell almost everything in the world economy. When too much fiat money is created,
this erosion of real value is reflected by the rate of inflation over time. Consumer
Price Indices indicate the change in the real value of fiat money in the
world economy within their particular local economies. Countries that issue
government capital inflation-indexed bonds already have a Daily CPI that indicates the
daily change in the real value of their local currency within their local economy.
Example: The economy
grows in terms of GDP at 2 percent per annum. The monetary base needs to be increased.
The Central Bank – in the normal course
of its activities - orders new fiat money bank notes with a nominal value of USD 4 billion at a cost of USD 100 000 from the bank note
supplier, De la Rue, in the UK, for example.
Real value USD 4 000 000 000
Printing cost 100
000
Seigniorage 3 999 900 000
The Central Bank (country) is free to do whatever it wants with the newly
printed fiat money bank notes and coins in terms of its articles of association.
For example, lend it to commercial banks in terms of monetary policy in order
to create more fiat money (this time not printing new bank notes and coins) in
the economy via fractional reserve banking, buy new computers, new office
blocks, new cars, etc. The Central Bank can also pay the newly printed money as
a dividend to the Government who can do anything it wants with the newly printed
money – in terms of the constitution, e.g., pay civil service, army, police,
health services, military, education salaries, buy or develop / maintain nuclear
weapons, if it were a member of the official Nuclear Club (Russia, China, US,
Israel, UK, France, India, Pakistan, others ?), etc.
Countries like Zimbabwe, Panama, Ecuador, (Argentina, in the recent past) and
other Dollarized countries as well as the increase in the use of the US Dollar
outside the US economy continuously contribute in this way to the increase in
the short and long term welfare and security of the people of the
United States of America at no apparent cost to the people of the United States
of America for an indefinite period of time - to the possible detriment of the
people of these Dollarized countries. It would be a detriment if these
countries were able to do better for their people by not being Dollarized as
compared to the stability that Dollarization brings compared to its huge costs
as indicated above.
This avoidance of Dollarization is now possible in terms of the Daily Index
Plan, i.e., capital maintenance in units of constant purchasing power as
authorized in IFRS twenty three years ago plus daily inflation-indexing of the
entire money supply, both in terms of a Daily Consumer Price Index (the USD daily
parallel rate during hyperinflation). The Daily Index Plan results (guaranteed)
in the local economy being “Dollarized” in terms of constant local currency monetary and non-monetary items instead of actual United States Dollars. It results in the local economy
operating with monetary and non-monetary items of completely stable real value: i.e., constant (not
nominal) real value local currency monetary and non-monetary items of perfectly stable real value.
If Iran were to Dollarize her economy, the people of Iran would
continuously contribute to the short and long term welfare and security of the
people of the United States of America for an indefinite period of time
(forever) at apparently no cost to the people of the United States of America but
at a cost (e.g., continuous loss of seigniorage, etc.) to the people of Iran, if
Iran were to stay Dollarized for an indefinite period of time – possibly to the
overall short and long-term detriment of the people of Iran. This aspect needs credible,
specific value, verifiable and peer-reviewed research to determine its real economic
implications.
Seignoreige is a windfall profit which only comes about as a result of the
double-entry accounting model in the same way as capital, as we know it, comes
about. It is the initial accounting of a real value that exists or is newly
created in the economy: in the case of capital, as a result of laws (company,
commercial and other laws) and the existing real value of net assets. In
the case of seigniorage, as a result of the sovereign law of legal tender giving
rise to newly created real value in the economy (newly printed fiat
money bank notes and coins) and the accumulated economic value of all the
underlying value systems in the economy, e.g., sound governance, sound economic
policies, sound political policies, sound monetary policies (e.g., no oversupply
of the money base as indicated by inflation and hyperinflation), sound
accounting policies, sound educational policies, sound health policies, sound
international relations, sound legal system, sound defence system, etc.
Nothing of the above was or is specifically “engineered” by the government
of the United States of America or any entity in the US. All of it came about
as a result of specific historical economic circumstances that resulted in
Dollarization in the past. Dollarization in the past was a direct reflection of
the level of undestanding or lack of understanding of, e.g. the effect of the
stable measuring unit assumption (Historical Cost Accounting) in the economy,
daily inflation-indexing of the entire money supply, etc.
The US Dollar is almost always used for Dollarization. It is estimated that 50% of US Dollars is used outside the US economy because of the extraordinary success of the US economy and Federal Reserve Bank over the last at least 100 years: because of the faith people in general have in the US Dollar as a relatively stable currency and unit of account.
Chile, Angola, Turkey and especially the large Brazilian economy beat
hyperinflation without resorting to Dollarization. The Brazilian Real Plan in 1994 signalled the end of official
Dollarization as a remedy during hyperinflation. The Real Plan very successfully used the principles implemented under Dollarization without using
actual Dollarization in US Dollars to the great and indefinite advantage of the
people of Brazil.
Zimbabwe´s spontaneous Dollarization in 2008 occured outside the realm of
official monetary policy implementation: the povo (people) decided what to do,
not the government of Zimbabwe (Robert Mugabe) or the Central Bank (Gideon
Gono) as the agent of the government. Zimbabwe is a very open economy (on the
consumer level) surrounded by stable economies, especially the large South
African economy which could be up to 100 times larger than the Zimbabwean
economy.
As Nelson Mandela stated: (Economic collapse in) Zimbabwe was a case of
failure of leadership: clearly true as far as monetary policy, amongst many policies, was concerned.
There is absolutely no necessity for Iran now - or any other country in the
future - to Dollarize, except possibly in the case of spontaneous Dollarization
by the people of a relatively small economy in total economic chaos like
Zimbabwe in 2008. Spontaneous Dollarization cannot be controlled under a total
lack of official monetary policy initiatives in a very open economy. It is a
matter of survival for the people of the country and they take matters into their
own hands like they did in Zimbabwe in 2008 when the government is incapable of
looking after their economic well being.
Dollarization is not necessary at present (2012). All Dollarized economies
can successfully end Dollarization by implementing IFRS authorised capital maintenance
in units of constant purchasing power and daily inflation-indexing of the
entire money supply, both in terms of a Daily CPI. The correct implementation
of the Daily Index Plan is guaranteed (by proven economic, mathematical and
IFRS authorized accounting principles) to result in an economy operating in
constant real value local currency monetary and non-monetary items.
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Nicolaas Smith
Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.
