- The Washington Times - Wednesday, January 26, 2000

In the last couple of decades, the United States has provided hundreds of billions of dollars of direct assistance to the Third World and to multilateral institutions such as the United Nations and the World Bank. Sadly, this massive transfer of taxpayer money has not helped nations climb out of poverty. Indeed, there is substantial evidence that aid has hindered economic development by subsidizing bad policies (a bizarre specialty of the International Monetary Fund).

Many lawmakers, however, are unwilling to pull the plug on foreign aid. To some degree, the willingness to throw good money after bad is a heartfelt effort to alleviate the suffering in other nations. It may not work, but at least the intentions are noble.

Fortunately, if lawmakers genuinely want to improve living standards in developing nations, there is an alternative. Sen. Connie Mack, Florida Republican, is proposing legislation that would make it easier for other nations to adopt the U.S. dollar as their official currency. This one step, which would impose no burden on American taxpayers, would dramatically improve economic conditions in participating countries.

The reason is simple. Many developing countries have weak and unstable currencies, as evidenced by rapidly rising price levels. This inflation significantly disrupts an economy by distorting relative prices and creating uncertainty. Even worse, it undermines future prosperity by making investment much less attractive.

If nations adopt the U.S. dollar, however, these problems largely disappear. The Federal Reserve Board certainly has made its share of mistakes since it was founded, but inflation in America is much lower than it is among developing nations particularly since Ronald Reagan became president and the monetary policy mistakes of the 1960s and 1970s were reversed.

If allowed to use the U.S. dollar, people in other countries will have much greater reason to believe that money will retain its value. That means they will be able to make long-term contracts. Panama uses the dollar as its currency, for instance, and it is no coincidence that it is the only nation in Latin America where homeowners can get a 30-year mortgage. Long-term price stability also makes it much easier for workers and management to negotiate mutually beneficial labor agreements.

Perhaps even more important, adopting the U.S. dollar would make other countries much more attractive to the world market. Foreign investors (perhaps the biggest source of economic growth in the Third World) will be more inclined to build factories and create jobs when they have confidence the currency is strong. Moreover, using dollars would reduce transaction costs since imports and exports would not be complicated by concerns about exchange rate fluctuations.

"Dollarization" also has many indirect benefits. One reason many developing nations experience high inflation, for instance, is that politicians finance deficit spending by printing more money. If they switch to dollars, however, this option no longer exists and officials will have to be more frugal. Adopting the dollar also will force nations to modernize their financial sectors since lawmakers no longer will be able to use monetary policy to prop up and protect banks and other institutions that make decisions based on political connections rather than economic factors.

Yet if dollarization is such a good idea, why is it such a rare occurrence? There are two impediments. First, having a currency is sometimes seen as a matter of national pride and identity. Adopting the U.S. dollar may be economically rational, but segments of the population may resent the perceived loss of sovereignty (much as some protectionists try to argue that agreements to reduce trade barriers somehow reduce U.S. sovereignty).

The other roadblock to dollarization is that governments make a profit, called seigniorage, when they create money. A $100 bill, for instance, costs less than 5 cents to produce, but the government gets $100 of value when it is put in circulation. For countries considering a switch to the dollar, this loss of revenue is not a trivial matter. Argentina is interested in dollarization, but the loss of $750 million of seigniorage (which would instead accrue to the United States government) is one of the key sticking points.

This is where Mr. Mack's legislation would have a big impact. The Florida lawmaker's proposal would rebate about four-fifths of the profit back to the government of countries that switch to the U.S. dollar. In the case of Argentina, this would mean at least $600 million.

All told, this is a win-win situation. Countries that dollarize will get a much stronger currency, more economic stability, and rising levels of investment. America, meanwhile, gets a more prosperous trading partner and the satisfaction of knowing that a policy actually is helping to boost living standards.

Lawmakers have a choice: Continue with failed foreign aid programs that are bad for both taxpayers and recipients, or shift to dollarization, a policy that replaces good intentions with good results. This should be a clear choice, even in Washington.

Daniel Mitchell is the McKenna senior fellow in political economy at the Heritage Foundation.



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