Dual Monetary Systems in the Western Hemisphere and the Cuban Transition
Joseph M. Perry, Louis A. Woods and Jeffrey W. Steagall, University of North Florida, Jacksonville, Florida
Part II
IV. The Provision of U.S. Dollars for Dual Monetary Systems
In order for dual monetary systems to function, the United States must generate a money supply adequate to support all of the domestic financial needs of the country, and the needs of trade in countries using the dollar as an alternate currency. Those countries using the dollar for hand-to-hand trade, as well as for a store of value, will normally have a demand for currency, as well as for dollars in credit form.
The extent to which the dollar is now used by countries other than the United States has affected money supply growth and the composition of the money supply in the United States. According to recent analyses by Richard D. Porter of the Federal Reserve System, U.S. currency has steadily leaked from the domestic system over the past three decades. Porter's estimates suggest that, in 1970, 40 percent of all U. S. currency was circulating abroad. By 1993, approximately 70 percent of all currency was circulating outside the political boundaries of the United States.[19]
The analysis of changes in the U.S. money supply in recent decades suggests some tentative conclusions. As the data in Table 2 indicate, the currency component of the narrow money supply (M1) has dramatically increased as a percentage of the total, rising from 21.15 percent in 1963 to 28.48 percent in 1993. Since 1960, U. S. consumers and businesspersons have accepted and increased their use of various forms of electronic credit. Credit cards and debit cards are now routinely used for domestic purchases at grocery stores, gasoline stations, physicians' offices, and shops throughout the country, thus economizing on cash. It is even possible to pay some taxes and other government levies with credit cards. The availability of ATM facilities also permits a reduction in the average level of cash holdings. Given this trend, the share of cash in the total money supply would be expected to decline, rather than to rise.
Edgar L. Feige argues that the "cashless society," that was expected to arrive in the 1980's, failed of realization because of dual monetary systems around the world, all depending more or less upon the U. S. dollar, the growth of the domestic underground economy, and the growth of the international drug culture. He estimates that households in the United States hold only about 12 percent of the currency that has been issued and is putatively in circulation. Business firms hold another 10 percent, while the U.S. underground economy holds 4 to 6 percent. He estimates that currency circulation outside the country is 45 to 58 percent of the total. The remaining 14 to 29 percent is "missing," that is, not identifiably in any of the other categories of currency holders.[20]
Table 2. United States: Money Supply and Currency Measures, 1963-1993
YEAR MONEY SUPPLY CURRENCY SUPPLY CURRENCY AS
(M1) ($BILLIONS) PERCENT OF M1
($BILLIONS)
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00
Source: Board of Governors of the Federal Reserve System, Federal Reserve Bulletin, various issues.
Porter's estimates suggest that, in 1970, $19.6 billion in U.S. currency was circulating abroad. By 1993, about $224.98 billion was in foreign hands, an increase of over elevenfold. Only a rising demand for currency by foreign users could have supported this expansion. It follows that the currency must be performing economic functions that are perceived as desirable and valuable by the demanding individuals and agencies. It is equally obvious that the monetary policy makers in the United States have accommodated this demand.
As the foregoing examples suggest, a dual monetary system can be a positive stimulus to economic growth. It can tie a country more closely to international trade flows, and facilitate the movement of hard currencies into and out of the economic system. Under ideal circumstances, it is also an adjunct to a country's own financial system, supporting it without overwhelming domestic economic policy. Unfortunately, a dual monetary system may also emerge out of economic unrest and dislocation, often without the overt support and approbation of the national government.
Pérez points out that domestic inflation is often a sufficient cause for currency substitution. When a country's domestic currency depreciates, citizens begin to hold the more stable convertible foreign currency as a store of value. If inflationary conditions worsen, the substituted currency (typically the U.S. dollar) begins to be used as a medium of exchange, and domestic prices may be quoted in that money of account. In the worst case, the domestic currency depreciates to the point that its circulation is very limited, and the substituted currency becomes the primary medium of exchange.[21]
Capital flight is also cited as a reason for currency substitution. When domestic funds flow to investment opportunities in other countries, foreign currency deposits may be encouraged by government to improve the net foreign exchange position of the financial system. The extent and nature of these encouraged inflows will depend upon a complex of factors, including exchange rates, domestic and foreign interest rates, and expectations concerning conditions in both the foreign exchange and the domestic financial markets.[22]
Dual monetary systems, embodying currency substitution, may also emerge for other reasons. Countries that depend upon tourism for a significant portion of their national income may find it in their interest to encourage the domestic acceptance of foreign hard currencies, thus making it easier for tourists to enjoy the goods and services they offer. The acceptance level of U.S. dollars in circum-Caribbean countries noted in Table 1 reflects, in almost every instance, the existence of a large tourist industry, regardless of the existence of other causes for the phenomenon. This argument may be applied, perhaps with lesser force, to a country that develops a large export-import sector. Domestic deposits of foreign currency may be desirable to facilitate both exchange transactions and balance of payments adjustments.
Similarly, political instability may spur the holding and use of convertible foreign currencies. Uncertainty about the domestic currency and financial system, regardless of the level of domestic inflation and the state of the balance of payments, may be enough to stimulate currency substitution.
It appears that a dual monetary system may emerge for a variety of reasons, and may exert a combination of favorable and unfavorable effects on the domestic economy. The mix of impacts will depend upon the specific characteristics of the situation. It is clear that such systems do exist and function in many western hemisphere countries at the present time. It is also clear, as Pérez notes, that, once currency substitution passes a certain threshold level in a country, the process is generally irreversible.[23]
V. Formal and Informal Dual Monetary Systems as Engines of Growth
When the transition in Cuba occurs, the prolonged process of transforming a centrally-planned economy into a market-oriented state will require extensive structural changes and massive infusions of funds. Both political stability and macroeconomic stability are highly desirable, if not necessary, conditions for this period of change. Since "dollarization" of the Cuban economy has already taken place, essentially legalizing an already existent informal dual monetary system, it now becomes appropriate to consider whether that system should be maintained during the transition, or whether it should be altered, the better to accommodate economic growth.[24]
Following an earlier proposal by Moreno, Sanguinetty and Moreno have advocated the adoption of a formal dual monetary system by the Cuban government during the transition. Although both the U.S. dollar and the Cuban peso would be accorded unlimited legal tender status, the exchange rate between the two currencies would be permitted to fluctuate, according to market conditions. In essence, Sanguinetty and Moreno argue, there would be two parallel economic systems. The historically-established system, based upon centralization of power and socialized resources, revolves around and utilizes the peso. It is the system that must be transformed or eliminated. The emerging market-oriented system would be associated with the U.S. dollar. It is the system that would attract and mobilize the funds required for the transformation and growth of the Cuban economy.[25]
Sanguinetty and Moreno list specific disadvantages and advantages for the system. The disadvantages of monetizing the dollar include (1) limitations on the flexibility of policymakers to respond quickly to contingencies, (2) increased vulnerability to monetary policy decisions in the United States, and (3) possible injury to national pride at a very critical time. The advantages include (1) limitations on the power of Cuban policy-makers to mismanage the economy, (2) clear evidence to the Cuban population that there are two economic systems on the island, one requiring dismantling, the other requiring encouragement, and (3) the development of a mechanism to reallocate resources, especially labor, from the peso economy to the dollar economy. This last advantage would presumably mitigate or eliminate so-called "shock therapy."
This proposal has the implicit goal of tying the Cuban economy to the international market through the use of the U.S. dollar in daily life. The major problem with this proposal is the continued depreciation of the peso as the transition occurs. In dual circulation, the U.S. dollar will drive the peso out of circulation, as the peso loses its ability to serve as a medium of exchange and, particularly, as a store of value. Economic agents in Cuba will ultimately realize that holding pesos is irrational, and will join in the wholesale flight to the dollar. At this point, the Cuban monetary system becomes an adjunct to the U.S. economy, similar in many ways to the economy of Panama. The disappearance of the peso from circulation also signals a mixed bag of benefits and costs for Cuban policy makers. Tollefson sums up the situation for dollar-dominated Panama as follows:
In a sense, Panama could not have a monetary policy, because it lacked the instruments to implement such a policy, such as money creation and exchange-rate manipulation. In effect, Panama's money supply was determined by the balance of payments, by movements in interest rates, and by the United States, which controlled the number of dollars available for the country's international transactions.
Panama's monetary system has benefitted the country in numerous ways. The country has enjoyed almost automatic monetary and price stability. International transactions have been facilitated by the use of the United States dollar. No short-term transfer problems are associated with the balance of payments. The foreign exchange constraint felt by most developing countries has been obviated by the dollars circulating in the economy and the ability to borrow.[26]
In short, some elements of stability can be introduced into the Cuban economy, if the transitional government is willing to surrender some (perhaps a large part) of its sovereignty to the United States. These are among the points made by Moreno in his earlier paper. Given the acceptance of such a relationship, the peso could possibly be reintroduced later, at a new and realistic exchange rate, just as occurred in 1915. Whether the peso would have any more economic importance than the Panamanian balboa is doubtful.
A more basic question now arises: Can a dollar-denominated economy overcome all of the problems suffered by Cuba's economy? The answer must be negative. The fall of the peso is the result of fundamental economic problems, not the lack of a viable medium of exchange or a store of value. These causes, which are embodied in the capital goods and the technology of the peso economy, are the ones that must be addressed. A decade or more of restructuring, realignment, and recovery will face the transitional government. Cuba must find its own way into the future, building on its strengths and shoring up its weaknesses.
It should also be pointed out that when Panama was born, the country did not have to suffer an almost complete restructuring to develop market-oriented institutions. The country did not have to be reintegrated into the international trading system. And the country did not have to find new answers to the basic economic questions of "What? How? and For whom?". Pérez also points out that the dollarized Panamanian economy does not provide absolute security against the mismanagement of domestic fiscal policy. During the 1970's and early 1980's the Panamanian government adopted a strongly expansionist fiscal policy, which ultimately led to balance of payments problems and an economic contraction.[27]
VI. Conclusions
The following conclusions are suggested by the foregoing analysis and discussion:
1. Informal dual monetary systems operate throughout the Western Hemisphere, using the U.S. dollar as the second or alternate currency. Particularly in tourism-oriented countries, the expanded circulating medium thus created fosters higher levels of trade and generally encourages economic growth, apart from any other effects it may have.
2. The expansion of the narrow money supply in the United States, as well as its composition (currency versus credit) is responsive to the demands of its users. The currency needs of hemispheric dual monetary systems have been met in the past, and should be met in the future. The interface of the U.S. bank credit and credit card systems with those of foreign countries also support foreign demands.
3. Those countries in which the U.S. dollar is not legal tender have the institutional capability to pursue their own fiscal and monetary policies, so as to optimize the operation of the dual monetary system. The Latin American country in which the dollar is legal tender (Panama) enjoys a measure of economic stability, but does not enjoy the ability to plan its own economic future (apart from the treaty negotiated in 1979).
4. Cuba currently enjoys an informal dual monetary system using the Cuban peso and the U.S. dollar. The system has operated, even under tight government constraints and an active U.S. embargo, to bring dollars into the economy. It is likely that the threshold level of system growth has been passed, so that elimination of the U.S. dollar is impossible.
5. If the transitional Cuban government decides to adopt a formal dual monetary system, giving the U.S. dollar legal tender status, the peso will ultimately (and quickly) disappear from circulation. At that point in time, the Cuban monetary system becomes very similar to the Panamanian monetary system. The ability of the Cuban transition government to formulate domestic monetary policy will be limited or virtually eliminated.
6. The decline in the peso reflects the extensive and continuing deterioration of the Cuban economy, not a complex of monetary ills. Economic restructuring, privatization, infrastructure rebuilding, and institutional reformation are the tasks required to give renewed strength to the peso.
7. An informal dual monetary system will facilitate funds flows during the transition, as well as a formal system would work. Investment flows from the United States and other developed nations will stream into Cuba, regardless of the legal status of the dollar, and probably regardless of the structure of the monetary system.
8. The disadvantages of the formal dual monetary system listed by Sanguinetty and Moreno are persuasive, particularly the point concerning national sovereignty and national pride at a critical growth juncture. The dollar should not become legal tender. Cubans should decide their own destiny. Cuba should not become another Panama.
The final observation paradoxically favors all points of view: If the transition government is unable to mount an effective rebuilding and restructuring program, and cannot move quickly toward a market-oriented system, the peso will depreciate and ultimately disappear from circulation. It will disappear regardless of the institutional configurations of the monetary system, and will be replaced by the U.S. dollar. At that point, all arguments about the structure of the monetary system become moot.
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