Dollars for Moldovanians!

December 29, 2007 9:02 AM

Why don't small countries use the dollar or the euro in place of their own currency?

So I'm the President of Moldovania, a small, poor, corrupt country located somewhere in Africa/Latin America/Central Asia. We have trouble with inflation and would like to make international business easier, so I hit upon the idea of scrapping the national currency and using another major currency in its place.
Why do my economic advisors tell me this is a stupid idea? Is it because this would piss off the US/EU, and be in some way illegal, or would the move simply be suicidal in terms of abandoning control of my own economy? Has it ever been tried?

posted by greytape to work & money (15 comments total)

Some do. Montenegro uses the Euro - they're not in the EU or Eurozone yet. Ecuador and I think Panama both use the dollar - or did until the dollar tanked.

I think the biggest reason is that central bankers in either DC or Frankfurt will then make big economic decisions that affect Moldovania without as much as a how do you do to Moldovania. Think Interest rates, money supply etc.

I think (although I am not sure) that that is one big reason that Denmark and Sweden aren't in the Eurozone.
posted by xetere at 9:05 AM on December 29, 2007

Its called dollarisation, and many countries do.

Its not without it's downside, however, as your country's money supply is controlled, to no small extent, by another nations Central Banks decision making.
posted by Mutant at 9:08 AM on December 29, 2007

Some countries peg their currency to the dollar at a fixed rate. Argentina did this until recently, I think.
posted by Ironmouth at 9:21 AM on December 29, 2007

If you peg your currency (or use another country's currency, same thing) then you're trading freedom for stability. Many of the Middle Eastern oil-exporting countries do exactly this.

Why can this be a problem? Two reasons.

Reason one: say your country's business cycle isn't aligned with that of the country you're pegging to. For instance, you've got a stagnant economy right now while the country you're pegging to has a booming economy. Their central bank, to prevent their economy from overheating, will tighten the money supply, lowering demand, which might push your country into a recession.

Reason two: say your country gets richer, but the US/EU doesn't (like, for instance, you're Kuwait and the price of oil goes up). Everybody now wants to buy your stuff, so they give you lots of dollars. So that's great, you use it to buy lots of fancy cars and so forth. But the problem is, your country isn't actually producing any more than it used to be, particularly non-tradable goods like haircuts. So what happens is the price of everything you can't import goes through the roof (i.e. there's lots of inflation) which has some negative consequences for the economy. If you had a floating currency, what would happen instead is the value of your currency would go up: you'd still have more purchasing power abroad, but without the negative effects of inflation.

But the positive part is that people--particularly borrowers--don't need to trust your government not to try and print money if it gets into a tight fix, because they're not allowed to print the money they're using. This leads to currency stability, lower inflation expectations, and better borrowing terms.
posted by goingonit at 9:36 AM on December 29, 2007 [3 favorites]

and I meant lenders rather than borrowers above
posted by goingonit at 9:36 AM on December 29, 2007

Inflation is method of especially taxing the lower middle and working classes, the unpropertied ones. Controlling the supply of your own currency gives you a quick way to constrain the wealth (re)distribution within your country. Handing over control of that to outsiders reduces your hegemonic manoeuvrability while benefitting from currency stability. Some countries desiring tight hegemony rig this tradeoff by setting dual currency structures, an internal one for mass consumption (and taxation), and an external one pegged to a larger currency, with non-market-driven constrained or prohibited interconvertibility between the two.
posted by meehawl at 9:55 AM on December 29, 2007

"Some people thought it was very nice for the U.S. to put an Ecuadorian Indian woman on these American coins they made especially for us!"
posted by gimonca at 10:21 AM on December 29, 2007

In addition to the lack of economic control, there is also the advantage of being able to print money. Of course, if you print too much, bad things happen as others have noted, but there is an advantage there if done carefully.
posted by ssg at 11:03 AM on December 29, 2007

But as meehawl pointed out, the ability to print money when used to finance government spending is in effect a tax (people call it the "inflation tax") because what you're doing--in addition to the other distortionary effects of inflation--is taking a little bit of every single dollar in the country and appropriating it.
posted by goingonit at 11:15 AM on December 29, 2007

Malaysia did since the Asian economic crisis (I think they may still, but am not positive). It can get very expensive though. I think it was definitely a good thing for Malaysia. Kept the economy going and foreign investors don't get scared away.
posted by whoaali at 11:22 AM on December 29, 2007

goingonit: Yes, printing money is effectively a tax, but it allows governments to keep their income, sales, and other direct taxes lower thus keeping the populace happier, and so on. If a country adopts another country's currency, then the other country can effectively subject the adopting country to this tax by printing more money. Surely avoiding having this tax go to a foreign government would be considered an advantage.
posted by ssg at 11:36 AM on December 29, 2007

Well, the dollar is already in practical use in nearly every country in the world.

Of those that are somewhat pegged, 7 Countries Considering Abandoning the US Dollar (and what it means) explains some of the different reasons why pegging can be a problem.

See also the Eurodollar, which is when individual investors (to simplify) try to do the same hedging your hypothetical president is. The term is no longer as important, especially since the rise of the Asian Tiger economies, as there are more places than Europe to bank your dollars.

A close analogue to this is the use of the dollar as a reserve currency. The USD remains the top currency in this market, which has immeasurably helped the US economy for most of the postwar era. It is not necessary to actually peg the currency to do this; it's a way of playing arbitrage and managing risk.

This has lately become a major risk for the US due to the spectacular growth of China as an economic power and a trading partner. China holds so much US debt as a means of propping up the renminbi/yuan that if the Chinese economy goes into a deep recession we could face a major crisis. So far, this has threatened to happen a few times, and has always been averted. (It would be expensive for China as well and throw a lot of Chinese out of work.)

While there have been a few countries that have used an overt or covert peg to the dollar, most of them have had strong trading relationships with the US. It hasn't been as important to other countries. What has happened instead is a rise in regional banking systems. The EU has experienced much of the effects of a peg, on both the up and down sides, among the members in the Eurozone. It's good for some of them, not so good for others. But due to the EU's status as a transnational system, this has been offset somewhat by national and industry-level subsidies. The beginning of the Euro period and the years directly leading up to it were a bit rocky for some of the members.

This is also behind the new Bank of the South, an international development bank owned by and for several South American countries. While it's touted in part as a rejection of the Washington Consensus, and US-based international banking through the World Bank and IMF, it's also simply a good idea. They're not pegging currencies, but they are pooling assets. If the continent or the MERCOSUR trading pact ever become a stronger transnational system like the EU it could be a means to a central monetary policy. At the very least it will strongly encourage cooperation.

So, there's more than one way to achieve the benefits cited.
posted by dhartung at 4:37 PM on December 29, 2007

whoaali: Malaysia removed the peg either earlier this year or last year, but it has been relatively stable - about RM3.50 to RM3.70 to the dollar. Removing the peg was a good thing as it makes US items more affordable.

National pride could also be a big thing. Some countries make a big deal out of using their own currency.
posted by divabat at 5:07 PM on December 29, 2007

Why has no one mentioned the CFA Franc?
posted by parmanparman at 5:43 PM on December 29, 2007

as has been mentioned already, montenegro did this - mostly it was a political decision, they wanted to be financially separate from serbia (who at the time they were still partnered with in the fallout of yugoslavia). so at the time when they wanted to give themselves some independence, they used the deutchmark internally. they would only deal in notes though, not in coins. so whenever you purchased something from a store, and required small amounts of change, they would give you small token items to bulk up the purchase (sweets, tissues etc...). it was quite frustrating sometimes, and incredibly useful others. legally the serbian dinar was an accepted currency, but noone would deal directly with it - you'd have to broker a change into deutchmarks. at the time when i was there, everyone and their dog would do an exchange using the blackmarket rates (often a lot better than the banks rates).
posted by dnc at 3:01 AM on December 31, 2007