Hidden and unknow cost of Dollarization (gain to the US)

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

1. The entire monetary base (money supply) has to be substituted with US Dollars.
2. The Central Bank cannot implement any independent monetary policies once the economy is Dollarized.
3. 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:

1. 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. 
2. Interest rate policies
3. 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.
4. 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.