Dollarization, or how to avoid the devil's embrace
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.  The tiniest of the seven Central American countries (smaller than Southern Ontario's Golden Horseshoe), El Salvador is the third richest. At $6,400 (U.S.), per capita GDP exceeds the Central American average by 30 per cent. Notwithstanding the global economic meltdown, real GDP increased last year by 3.2 per cent. In January, the International Monetary Fund reported that El Salvador's economy was in fine shape – with strong economic fundamentals, a moderate debt-to-GDP ratio and no balance-of-payments problems. “The impact of the global crisis on El Salvador,” the IMF said, “has been limited.”  Since El Salvador's civil war ended in 1992, the conservative ARENA party has governed the country with remarkably disciplined fiscal policies, pursuing classically liberal economic principles – selling off state enterprises, deregulating much of the economy, privatizing the country's pension program – and “dollarizing.”  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 and who brilliantly described his reasons for adopting the U.S. dollar in an allegorical work contained in  Playing Monopoly with the Devil, published by Yale University Press in 2006. Mr. Hinds's novella forms only the first chapter of the book but, by itself, makes the rest of the book optional.   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.  In his fantasy, Mr. Hinds invents a stereotypical Central or South American republic in which a politician named Dema Gogo has been elected president. His dilemma is authentic: In such a poor country, how can he find the money to do the good things he wants to do? Dema Gogo arranges for a chat with the devil in the presidential gardens. He offers cognac, a fine Cuban cigar and his friendship.  The devil has already consulted with his own adviser, Dr. Werner von Bankrupt, “in my dominions below.” Dr. Bankrupt's advice is succinct: “Issue your own currency, the gogo, with your face on each coin and bill.”  The inevitable monetary temptations ensue. The devil proposes that President Gogo establish a central bank – everyone else has one. Mr. Gogo wishes that the devil could run it, musing it was a “pity that he couldn't, on constitutional grounds. The devil wasn't a national. He met all other requirements.” In Mr. Gogo's first term, the official exchange rate of the gogo rises to one billion gogos for one U.S. dollar. On the black market, it rises to 1.5 billion gogos. Financial crises pile up, one on another. The banks stop lending. Mobs rule the streets.   Desperate, Mr. Gogo meets the devil one last time. They meet again in the presidential gardens.  “What's going on, my friend?” the devil asks.  “A mob is chasing me,” Mr. Gogo says. “They don't understand how difficult it is to manage the macro-economy.”  The devil walks to the entry of the garden and shouts to the mob: “He's in here!”  One shouldn't spoil the dramatic ending. Suffice it to say that, in the hyperinflationary end, the devil needs one trillion gogos to buy one U.S. dollar. Or, as he tells Mr. Gogo: “At today's exchange rate in the black market, I paid about a buck fifty [for your country]. That was a fair price.”   El Salvador escaped this bleak destiny – but will it continue to do so? With the leftist FMLN set to assume power for the first time since the civil war of the 1980s and early nineties, will the devil finally get his way? Will the political party descended from Marxist guerrillas abandon El Salvador's American dollar currency? (The FMLN gained a three-seat margin in national elections held last week.)   The answer, apparently, is no. President-elect Mauricio Funes insists that his new government “will not reverse privatizations, not jeopardize private property.” He has promised the IMF that he will keep the discipline of the dollar.  Until this week, the devil could have bought Zimbabwe for a buck fifty, too. Based on Manuel Hinds's analogy, President Robert Mugabe's dollar could be best described as the mugabo.   In the end, people needed a dollar bill with 26 zeroes to buy a loaf of bread. The hyperinflation ended abruptly this week, almost overnight, when Zimbabwe adopted dollarization-plus – the legal use of any currency. All heaven rejoices.(Globe and Mail, Toronto/Canada)