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Posted on September 28th, 2012, by

Today, the US dollar is the major international currency. The influence of the US dollar is particularly strong in American countries, especially in South America, where the level of dollarization of national economies is extremely high. In such a situation, the question concerning possible effects of the dollarization of national economies naturally arises since this process is progressing and, before, the recent economic has struck, the dollarization tended to become a widely ”“spread phenomenon. Hence, it is necessary to understand possible effects of dollarization and, in this respect, views of specialists vary consistently. On the one hand, the dollarization is viewed as a threat to the national economy and economic stability (Sachs and Laren, 80), while, on the other hand, Humpage and Dornbush suggest that the dollarization can be introduced with minimal losses to countries or even bring considerable profits to national economies.

On analyzing the current position of the US dollar practically specialists (Sachs and Laren; Humpage and Dornbush) agree that the US dollar is dominating in the international currency market. Naturally, the historical dominance of the US dollar in the international currency market determined its position as the major medium of international payment and exchange. In this respect, it should be said that the choice in favor of the US dollar would be a logical for a company entering a foreign market because the position of this currency in the international market is quite strong. On the other hand, such arguments as popularity of the currency cannot be applied to economy.

Instead, it is necessary to focus on purely objective reasons which can explain the position of the dollar as the main medium of international payment and exchange and, therefore, determine the choice of a company entering a foreign market in favor of this currency.

First of all, it should be said that by the mid-1990s the dollar was used in more than 80% of two-way transactions in foreign exchange markets. At the present moment, its use is still significantly outweighs the use of euro and is assessed around 70% of two-way transactions in foreign exchange markets, but it is worthy of mention that the share of euro steadily grows and, in actuality, euro is the major currency that tends to be uses in the rest part of two-way transactions. In fact, the US dollar is used worldwide and is used in all transactions, regardless companies involved. In practice, this means that the US dollar may be and is used even by European companies, while for the rest of the world the US dollar remains traditionally more preferable than any other currency.

In this respect, it should be said that the role of the US dollar in national economies of Latin American countries has increased dramatically.

For instance, Dornbush argue that such countries as Argentina, Equador and El Salvador have unilaterally chosen a currency board or outright dollarization (238). In such a way, it is obvious that the US dollar plays a determinant role as an international currency in America.

In actuality, for companies operating in North and South America, it is simply illogical to use euro or other currency but the US dollar in transactions since the losses in the result of such transactions may be quite substantial. In other words, it is quite logical that American companies, as well as non-American companies that operate in American market, avoid the use of other currencies but dollars simply to avoid transactional costs. Obviously, the use of the US dollar is consistently cheaper and, therefore, financially more preferable for companies.

In this respect, the spread of the dollar is also very important because, basically, transactional costs decrease proportionally to the spread of the currency. This means that due to the wider spread of the US dollar in the world transactional costs are lower compared to euro.

Moreover, the further use of the US dollar may be more convenient for a company than the use of euro again to the wider spread of the former compared to the latter. For instance, if a company receives a payment in the US dollar naturally it would more preferable for a company to use this currency in further transaction, instead of wasting costs on exchange of the US dollar on euro. Furthermore, some companies may simply refuse to accept euro as a medium of payment because of the limited spread of euro. This is particularly true not only for the US companies but also companies situated in North and South America, as well as in many Asian and African countries.

At the same time, many companies operating in the international market are multinational corporations. This means that they operate worldwide and, therefore, they also need to use the currency that would be spread worldwide and which could contribute to saving transactional costs. In actuality, the choice of multinational corporations in favor of the US dollar is quite logical since there are a lot of transactions worldwide they are involved in and, what is more, they also need to invest worldwide (Kenen, 315). In other words, it would be a serious problem of a multinational corporation chose euro and invested in American market or any other market in the world where the position of euro is extremely weak. In such a situation, this multinational corporation would need to increase transactional costs because of the exchange of the currency in order to use the US dollar. Obviously, in such a situation, the use of the US dollar by a company, which is supposed to operate in different countries, is more preferable since it help not only save costs but also increase the speed of transactions.

In such a context, the suggestion of Dornbush seems to be quite logical, since he refers to the example of the EU, which was started as a monetary union with the use of common currency for member countries (238).   Basically, Dornbush develops arguments in favor of the dollarization because it brings considerable benefits to countries, especially those which international trade is oriented on the US. In fact, among the number of advantages of the transition to the dollarization, Dornbush names the simplification of the trade between countries (239). This means that countries will use one and the same currency in their transaction that will minimize the costs of the transactions compared to the situation when multiple currencies are used. At this point, it is worth mentioning the fact that such disturbances of opponents of dollarization as the loss of price flexibility can be rejected since, according to Dornbush, most of these disturbances are temporary rather than permanent (239) that means that, in the future, the situation will get stable. At the same time, there are considerable advantages of the dollarization. For instance, the dollarization can lead to a dramatic decline in interest rates with all attendant benefits (Dornbush, 240). As a result, national economies can benefit due to the decline of interest rates and countries can experience the economic growth due to the growing investments and growth of financial markets. Another important benefit of dollarization is the stabilization of currency, financial markets and economies at large since the dollarization contributes to the “transformation of the financial sector and the lengthening of agents’ horizons”ť (Dornbush, 240).

On the other hand, Sachs and Larrain argue that the dollarization can have a number of drawbacks, which actually can outweigh all the positive effects of the dollarization. To put it more precisely, they argue that the recent economic and financial crisis and ongoing economic recession in the USA can be viewed as perfect evidence of possible risks of the dollarization, which are so high that recommendation of specialists concerning abandoning of national currencies by developing countries are imprudent and even dangerous for the national economies (Sachs and Larrain, 80). Sachs and Lorrain argue that the dollarization is a risky step, which can actually deteriorate consistently the situation in national economies of countries which agree on the dollarization (80).Instaed, they suggest the introduction of flexible exchange rate, which can be more effective than dollarization (Sachs and Larrain, 80).  In this respect, they argue that the flexible exchange rate has a number of benefits. First of all, the flexible exchange rate increases the discipline in financial markets and transactions (Sachs and Larrain 81), which is very important in the situation when economy suffers from recession. In addition, the flexible exchange rate increases the possibility of easier overcoming financial crisis in the USA and other countries since flexible national currency is more able to the resistance when it is not bound to the US dollar or other foreign currency (Sachs and Larrain, 84). Moreover, Sachs and Larrain warns that the failed defense of the national currency, in case of maintenance of fixed exchange rate, can be extremely costly and, therefore, cannot be justified (84).

Nevertheless, it does not necessarily mean that there is no way of out of such a controversy between proponents and opponents of dollarization and fixed currency rates bound to the US dollar. At this point, it is possible to refer to the research conducted by Humpage, where the author suggests a solution which can minimize possible risks or negative effects of dollarization of national economies. To put it more precisely, Humpage argues that the US can support dollarization by sharing seigniorage that it acquires from the foreign use of the US dollar (4). In fact, Humpage stands on the ground that sharing seignorage with countries that have chosen dollarization will minimizes their losses and risks accompanying dollarization and maximize benefits of dollarization (5).

Thus, taking into account all above mentioned, it is possible to conclude that the dollarization is quite a controversial step, but many countries tend to choose dollarization or establish fixed exchange rates bound to the US dollar since, today, the US dollar remain the dominant international currency. In such a situation, it is obvious that drawbacks and risks of dollarization are too high, while the maintenance of flexible currency rates and protection of national currencies can increase transactional costs and, therefore, losses of companies oriented on international trade. Therefore, it is necessary to find the solution, which can minimize negative effects of dollarization and maximize its benefits. In this regard, the suggestion made by Humpage can be one of possible solutions of the problem.

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