The Economy -- Dollarization -- its potential benefits

Over the next few weeks, I will be devoting a greater percentage of blog posts to economic topics. The economy and the world financial crisis pose large challenges to the incoming administration of Mauricio Funes and the FMLN. Funes made many promises in the election campaign, but economic realities may impinge on how many of those he can fulfill.

One unique factor about El Salvador's economy is dollarization. El Salvador abandoned its own currency at the beginning of this decade and only uses the US dollar now. An article from the Canadian paper the Globe and Mail makes the argument that dollarization has played an important role in promoting the stability and growth of the economy in El Salvador:

El Salvador has no domestic (“sovereign”) currency and, hence, no monetary policy of any kind. Almost alone in the world, El Salvador has no central bank. Lucky El Salvador. This tiny country has used the U.S. dollar as its official currency for eight years – and has avoided most of the problems experienced by poor countries that try to act like rich countries....

Why would a country freely abandon its sovereign currency? Why would a country voluntarily surrender its paper money, a symbol of nationhood? The answer is that El Salvador decided that its currency was too important to entrust to its own politicians, its own financiers, its own industrialists – and, indeed, its own people. One of the principal agents of dollarization was an economist named Manuel Hinds, who twice served as the country's minister of finance....

Mr. Hinds argues that central banks are apt, for poor and underdeveloped countries, to embody a Faustian deal that invites the deliberate corruption of currencies and incites either populist excesses at best, or mob violence at worst.

Back in October 2005, I wrote about some of the downsides of dollarization, which include ceding control of the country's destiny to the US Federal Reserve. As the US generates trillion dollar budget deficits for years to come to stimulate its economy, the spectre of inflation and a weak currency may be in the future for El Salvador. In the campaign, Funes indicated he would not reverse dollarization, although that had been a longstanding position of the FMLN. There is also ongoing talk of a new Central American currency among the countries in the region.