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Playing Monopoly with the Devil

Playing Monopoly with the Devil: Dollarization and Domestic Currencies in Developing Countries

Manuel Hinds
Copyright Date: 2006
Published by: Yale University Press
Pages: 304
https://www.jstor.org/stable/j.ctt1npnzs
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  • Book Info
    Playing Monopoly with the Devil
    Book Description:

    Why should a developing country surrender its power to create money by adopting an international currency as its own? This comprehensive book explores the currency problems that developing countries face and offers sound, practical advice for policy makers on how to deal with them. Manuel Hinds, who has extensive experience in real-world economic policy making, challenges the myths that surround domestic currencies and shows the clear rationality for dollarization or the use of a standard international currency.The book opens with an entertaining story of the Devil, who, through a series of common macroeconomic maneuvers, coaches the president of a mythical country into financial ruin. This ruler's path is not unlike that taken in several real developing countries, to their detriment. Hinds goes on to introduce new ways of thinking about financial systems and monetary behavior in Third World countries.

    eISBN: 978-0-300-12977-9
    Subjects: History

Table of Contents

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  1. Front Matter
    (pp. i-viii)
  2. Table of Contents
    (pp. ix-x)
  3. Acknowledgments
    (pp. xi-xii)
  4. Prologue: Playing Monopoly with the Devil
    (pp. xiii-xxiv)

    This is the tale of what happened to Dema Gogo, ruler of a poor country in an underdeveloped area of the world, when he discovered that he could issue his own currency. The tale starts with a conversation he had with the Devil himself, the day after his inauguration as President of the Republic. Drinking a glass of cognac and smoking a Cuban cigar on the veranda of the Presidential Palace, enjoying the sight of the luscious tropical plants that grew in the garden one floor below, he was pondering what he could do to assure his reelection five years...

  5. Introduction
    (pp. xxv-xl)

    Why should a developing country surrender its power to create money by adopting as its own an international currency?

    This book addresses this question.

    For most economists, the book should be very brief, a few paragraphs long. It should limit itself to state the conventional answer to this question, which would be that a country should never surrender this power. Such an answer would be based on impressive theoretical and institutional foundations.

    Theoretically, there are arguments on trade, finance, and fiscal management grounds. On the side of trade, the argument is that flexibility to modify the exchange rate allows domestic...

  6. Part One. The Unfulfilled Promises of Local Currencies

    • Chapter 1 The Standard of Value and the Reversed Liquidity Trap
      (pp. 3-15)

      Money started its long career in history as a means of exchange: the currency that everyone accepts in payment. With time, however, it evolved into something much broader than this in three steps, each larger than the precedent. First, it led to the creation of the banking system, which multiplied the money actually printed by the sovereign so that in addition to the currency bills, people could use checks and other drawing instruments against their deposits in the banks. In modern times, money exercises its payment function in many other ways, including credit and debit cards, as well as the...

    • Chapter 2 The Unfulfilled Promises in the Financial System
      (pp. 16-52)

      International currencies can play the role of standards of value for several reasons. The main one is that they cover large and diversified areas, which can meet all the economic needs of their inhabitants with world-class quality and efficiency. Because of this diversification, substitution effects predominate over the income effect when they depreciate relative to other currencies. In this way, for example, when the dollar devalues relative to the yen, people buy fewer Japanese and more American goods and services. The income effect is practically zero because prices and real wages measured in the domestic currency remain the same. Thus,...

    • Chapter 3 The Unfulfilled Promises in Trade and Growth
      (pp. 53-81)

      The idea that real devaluations promote the growth of exports is probably the best known of the arguments in favor of having a local currency. The idea is so entrenched that the word “competitiveness” has been associated with the weakness of the currency even in the popular press. People say that a country becomes more “competitive” when it devalues more than its trade partners. When discussing dollarization, the people’s first reaction is to say that a country lacking the power to devalue the currency would become uncompetitive. The underlying logic in this assertion is that devaluations reduce wages in terms...

    • Chapter 4 The Costs of Stability
      (pp. 82-106)

      We saw in chapter 3 that the regime of floating domestic currencies, which in developing countries has meant a regime of continuous devaluations for most of the time, has failed to produce what it promised in terms of high export growth rates and economic activity in response to devaluations. There are many other variables that intervene in the determination of competitiveness. They are so strong that the positive relationship could not be found between real devaluations and the growth of exports and economic activity that common opinions would lead us to expect. Moreover, in many cases, we found that the...

    • Chapter 5 Missing Financial Globalization
      (pp. 107-118)

      One of the most damaging effects of the instability of local currencies in developing countries is that it distorts the perspective of economic policy. The stabilization of the local currency becomes the overriding objective of the government. Given the repeated failures in attaining such objective, adjusting to unstable monetary conditions becomes the top priority item in the agenda of both the public and private sectors. A substantial portion of people’s energy goes into continuously adjusting to high and variable rates of inflation and devaluation rather than into economic development. The study and practice of economics collapses to the obscure art...

  7. Part Two. The Reversed Liquidity Trap and Financial Crises

    • Chapter 6 The Financial Risks of Monetary Regimes
      (pp. 121-135)

      The conviction that countries must have their own currencies and the power to devalue them has another dimension, in addition to those discussed in part 1. It is their supposed usefulness in case of a financial crisis.

      The idea that local currencies are most useful during financial crises is based on three main arguments: First, devaluation has become unavoidable in all financial crises in developing countries. If the currency cannot be devalued, something unimaginable could happen. Second, without a local currency, the central bank cannot print the money that is needed to satisfy the run on deposits. Third, by increasing...

    • Chapter 7 The Currency Origins of Financial Crises
      (pp. 136-166)

      The expressionfinancial crisisevokes two different phenomena. First, it can be used to refer to cataclysmic runs on banks, such as those that took place during the Great Depression of the 1930s. Second, it can be used to refer to widespread insolvency in the banking system, even if there is no run on the banks. In this chapter, I deal with the two phenomena; for clarity, however, I reserve the expressionfinancial crisisfor the cataclysmic events associated with severe lack of liquidity.

      Banking runs are always associated with illiquidity, and illiquidity is frequently associated with insolvency. However, solvent...

    • Chapter 8 The Myth of the Lender of Last Resort
      (pp. 167-178)

      One of the most popular arguments in favor of local currencies is that they allow countries to have a lender of last resort to support their banks in times of crisis. I would respond that if this were true, ministers of finance and central bank governors would not rush to Washington and New York to get dollars when they have a financial crisis. They would stay comfortably at home, printing money, saving themselves the bad moments they go through when questioned by bankers and listening to the conditions imposed by the International Monetary Fund (IMF) to provide the money which,...

    • Chapter 9 The Solution of Crises and the Aftermath
      (pp. 179-188)

      Do local currencies help in the solution of crises? In the previous chapter, we found that the powers of the so-called lender of last resort are mythical in the case of developing countries. Now, the question is, do they help in other ways?

      The evidence suggests that they do not help, and actually complicate the solutions for exactly the same reasons that turn them into the trigger that unravels the crises. We can see that the solution of crises in countries with local currencies requires calming down two markets in panic—the currency and the financial ones—while in a...

    • Chapter 10 The Counterfactuals
      (pp. 189-194)

      What are the counterfactuals to this analysis of crises? The usual argument to defend devaluations is that they become inevitable when countries have severe macroeconomic and financial problems. This, however, happens only because they have a local currency vulnerable to devaluation.

      There are two kinds of counterfactuals. The first is the behavior of foreign currency deposits during the crises of countries with local currencies. In all cases, they either kept on increasing while those in local currencies were falling fast, or, when the run on local currencies was already threatening the banking system, they fell at a much slower pace...

  8. Part Three. The Optimal Currency Area and the Choice of Currency

    • Chapter 11 The Conventional Optimal Currency Area Theory
      (pp. 197-219)

      What are the implications of the foregoing analysis for the fundamental question about the choice of a currency regime: Should a country have a currency of its own or adopt an international one?

      This question is routinely dealt with using the criteria established by the conventional optimal currency area theory. According to these criteria, a country should have a currency of its own if it meets the conditions outlined in table 11.1.

      Given all the facts that we have analyzed in previous chapters, we can ask ourselves how optimal the optimality of the conventional optimal currency area theory is. A...

    • Chapter 12 Toward a Redefinition of an Optimal Currency Area
      (pp. 220-231)

      The objective of a monetary regime must be to maximize the probabilities of a smooth adjustment to the unpredictable developments of a globalized economy. The conventional optimal currency area theory seeks such flexibility through the freedom of the currency to change its value relative to that of the others. As we have seen previously, this approach has failed in most, if not all, the developing countries. In fact, the theory provides little guidance beyond rating as optimal regions that share some common external problems.

      As discussed in chapter 11, we need a definition of what an optimal currency area is,...

    • Chapter 13 Conclusions
      (pp. 232-234)

      We have reached the end of the book, and can answer the question I posed at its beginning—Why should a developing country surrender its power to create money by adopting an international currency as its own? The answer, in a nutshell, is that it is the only way in which it may access a truly optimal currency area.

      This answer should not be surprising; it is in full agreement with the kind of economic reasoning that has become the mainstream of the discipline in the last two hundred years. In fact, the idea that countries should detach themselves from...

  9. Epilogue: Werner von Bankrupt on the Art of Buying Countries with a Buck-Fifty
    (pp. 235-244)

    The Devil went to Dema Gogo’s country with ten of his underlings six months after its catastrophic currency crisis. They had a great time. Everything was cheap for them, to the point that they could dine in good restaurants for two bucks—wine, desserts, and lavish tips included.

    “These guys are in very good shape!” he told von Bankrupt when going back to headquarters. “Look how cheap everything is for them! I met a journalist with a prestigious magazine and he told me that this was because their dollar purchasing power parity, which he referred to as PPP, was very...

  10. Notes
    (pp. 245-248)
  11. Index
    (pp. 249-255)