Fortune issue: November 9, 1998
ECONOMICS: THE BENEFITS OF DOLLARIZATION
Let's Pass the Buck to Russia
N. Gregory Mankiw
When Andrei Kozlov, deputy head of Russia's central bank, was asked recently how his country
would deal with its teetering banking system, he reportedly replied, "Emissions, of course,
emissions." By this he meant that the new communist-influenced government would turn to an
old standby of central banking: printing money. U.S. Deputy Treasury Secretary Lawrence
Summers was quick to point out the folly of such actions. The inevitable result of such
"emissions" is hyperinflation, followed by economic and political chaos.
Why do central bankers pursue such destructive policies? And what can be done to stop them?
Thinking about the second question reminded me of a talk I heard in the early 1980s. Then, as
now, many developing nations were suffering from high inflation and depreciating currencies. A
young hotshot economics professor proposed a novel solution: Give up. He argued for
dollarization--that these countries should abandon all attempts at controlling the value of their
domestic money and simply adopt the U.S. dollar.
That hotshot was none other than Lawrence Summers. Since becoming a Treasury official,
Summers has been offering such prudent advice as pumping billions of taxpayer dollars into the
secret society called the IMF. But maybe he should have stuck with the dollarization idea.
Dollarization is a natural consequence of monetary instability: When a currency becomes
unreliable as a store of value, people turn to alternatives, such as cigarettes, vodka, or the U.S.
dollar. Letting dollarization run its course may be the most effective way to stabilize the Russian
Of course, it's not easy for a government to junk its own currency. It's an economic leap of
faith--getting rid of the domestic currency means getting rid of domestic monetary policy too.
The U.S. economy would be less stable if we were to adopt, say, the British pound. Yet in many
other countries, such as Russia today, central bankers are less likely to be a source of stability
than of mischief. Taking away their powers and piggybacking on U.S. monetary policy would be
a step in the right direction.
Dollarization is, in a sense, the most extreme form of a fixed exchange rate. In countries with
currency boards, such as Hong Kong and Argentina, the domestic currency is pegged to the U.S.
dollar with a central bank commitment to hold sufficient dollar reserves. Yet even these systems
do not ensure confidence in the domestic currency, because the central bank could abandon its
commitment at any moment. In a dollarized economy, by contrast, a crisis of confidence in the
central bank is impossible. Indeed, there would be no need for a domestic central bank at all.
This isn't to say that replacing the ruble with the dollar would solve all of Russia's problems. A
stable currency does not make crime, price controls, or fiscal insolvency any more tolerable. But
at least it would take hyperinflation off the list of things Russians have to worry about.
This brings me back to my first question: Why do central banks pursue hyperinflationary
policies? In the case of Russia today, the answer may not be much of a mystery. Here is John
Maynard Keynes, writing shortly after the 1917 Russian Revolution:
"Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch
the currency. By a continuing process of inflation, governments can confiscate, secretly and
unobserved, an important part of the wealth of their citizens. By this method they not only
confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually
enriches some. . . . As the inflation proceeds and the real value of the currency fluctuates wildly
from month to month, all permanent relations between debtors and creditors, which form the
ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and
the process of wealth-getting degenerates into a gamble and a lottery.
"Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis
of society than to debauch the currency. The process engages all the hidden forces of economic
law on the side of destruction, and does it in a manner which not one man in a million is able to
Is it any surprise, then, that Mr. Kozlov and his comrades are now turning to "emissions"?
N. Gregory Mankiw is an economics professor at Harvard and the author of Principles of
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