by Wayne Chen (Gleaner 2009)
The recent rapid slide in the Jamaican dollar and hike in interest rates have heightened fears of a future of economic instability and the global financial meltdown has only served to turn fear into despondency.
Back in 1995, Jamaica was faced with low growth, high inflation, high interest rates and a sliding dollar. Seeking to be proactive in the face of a looming crisis, the Private Sector Organistion of Jamaica commissioned Alternative Monetary Regimes For Jamaica by Steve H. Hanke and Kurt Schuler.
They proposed three options to stabilise Jamaica’s economy: full dollarisation, joining the Eastern Caribbean Central Bank, or establishing a currency board.
Given what has happened to our economy since 1995, miasmic growth, a financial sector crisis, and regular bouts of instability, I believe that Jamaica needs seriously to consider the options proposed, but personally I am in favour of full dollarisation.
A few months ago, flying into Panama City, I was struck by its ultra-modern skyline, an amazing development in a country that was poorer than Jamaica not too long ago and in a city that had been racked by conflict as recently as 1989. My taxi driver boasted proudly that there were over 80 high rises under construction in the city. I could not help but wonder whether its use of the United States (US) dollar, legal tender since 1904, was a significant contributor to Panama’s buoyant economy.
I believe that full dollarisation, discarding the Jamaican dollar and adopting the US dollar as our legal tender, would reduce Jamaica’s “country risk premium”, the surcharge we all pay as insurance against exchange rate risk, high inflation and our other macroeconomic ills that make long-term planning virtually impossible.
Today, I favour dollarisation over the other options because it is the most resistant to political interference and once established, the most difficult to undo.
Adopting the US dollar would immediately protect our savings and pensions by ending devaluations and bringing inflation and interest rates down toward those that obtain in the US. Ending the devaluation and inflation expectations would eliminate speculative attacks on our currency and provide a stable, credible and secure economic and investment climate. This would lead to a more stable capital market less vulnerable to sudden capital outflows and a balance of payments less prone to crises.
Lower country risk would enhance Jamaica’s attractiveness to local and foreign investors and increase the possibility of more stable longer-term investments and sustainable economic growth.
Many Jamaican businesses and individuals already use US dollars or denominate transactions in US dollars to protect themselves against devaluation of the local currency. They have already internalised the US dollar as a measure and store of value and marker of financial performance.
Full dollarisation would mean further integration into the US, and by extension, the world economy. It is significant to note that despite all the talk in recent years of the US being replaced by the Euro Zone or the BRIC (Brazil, Russia, India, China) countries as the engine of the global economy, the rest of the world is looking to the US and President Obama to pull us out of the recession.
But the most powerful argument for full dollarisation may be that it would enforce fiscal discipline on present and future governments and enhance policy credibility by preventing the printing of money to finance spending.
Of course, there are also significant disadvantages to full dollarisation. If Jamaica gives up the power to print money, it loses control of its monetary policy to the US Federal Reserve and consequently, important tools to respond to economic crises.
The Bank of Jamaica would also lose the ability to collect seigniorage, the profit gained by issuing the Jamaican dollar. When El Salvador dollarised it lost an estimated 1.3 per cent of gross national product annually due to the loss of seignorage profits and the loss of the interest it would have earned on its net international reserves.
The Bank of Jamaica would also lose its role as the lender of last resort to the Jamaican banking system. This is an important point as while the central bank may be able to provide short-term emergency funds from its reserves to help troubled banks, it could face a serious challenge to cover withdrawals in the event of a wide-scale run on bank deposits.
Jamaica would also have to meet all of its debt obligations, including those currently denominated in Jamaican dollars, in US dollars. If the reserves were insufficient this would mean having to borrow the money by running a current account deficit or accumulating a current account surplus.
The final disadvantage of dollarisation would be the loss of the Jamaican dollar as a symbol of independence and sovereignty. The Panamanians retain the right to mint their coins and we could do the same. Our national heroes may not be on the paper notes, but I suspect that they would not mind being on coins that retain their value for years to come.
El Salvador implemented dollarisation in 2001 as an extension of the free-market policies implemented since the end of its civil war in 1992. It was pushed by business and financial interests and supported by the conservative ARENA party. Unlike Ecuador, which dollarised in 2000 to quell hyperinflation, El Salvador had a stable, growing economy and the relatively low interest rate of 4.3 per cent the year before full dollarisation.
The real reason El Salvador dollarised seemed to have been the fear that the leftist FMLN party was gaining popular support and would have undone the economic policies that had tamed inflation and spurred growth.
So far, dollarisation has been a mixed blessing for El Salvador and there are useful lessons for Jamaica as we are both small, middle-income, developing countries with relatively open economies struggling with many of the same challenges.
Since dollarisation, El Salvador’s financial and business sectors have done very well as lending rates have fallen and exchange rate risks have been eliminated. However, the poor has struggled to keep up as prices have risen faster than wages, imports have grown faster than exports, the economy has grown at an average rate of 2.6 per cent since 2001 versus 3.6 per cent average for the six years before and there has been no windfall of foreign investment.
Today, the challenges of persistent poverty, relatively low productivity and high levels of gang and drug violence continue to offset the benefits of dollarisation.
The El Salvador case demonstrates that dollarisation may well be necessary to “lock in” the benefits of macro-economic stability, but not be sufficient to guarantee economic growth and development.
If we were to opt for full dollarisation, we would have to prepare well and proceed with caution as any mistake in our assumptions or implementation could foment an economic catastrophe.
We would have to address important issues such as whether the current level of foreign reserves is sufficient and there are significant costs associated with discarding the Jamaican dollar that would have to be assessed.
In the end, dollarisation is neither a panacea for fiscal indiscipline and macro-economic instability, nor a one-size-fits-all prescription for economic ill. It would not automatically make Jamaica more attractive to investors or make our businesses more competitive in the global marketplace. The Government would still have to do a lot of hard work and spend a lot of political capital to ensure that the public and private sectors are efficient and competitive. But this does not mean that the debate, discussion and planning should not proceed with urgency.
Wayne Chen is president of the Jamaica Employers’ Federation. Feedback may be sent to email@example.com.