Reference no: EM131327670

TRADING PESOS FOR GREENBACKS THE DOLLARIZATION OF SAN MIGUEL

With its economy shrinking and inflation being the highest in the western hemisphere, the president of San Miguel has decided that his country should abandon its own currency in favor of the US dollar.The president of this small, South American country reasons that the dollar will bring economic,and perhaps political, stability to San Miguel. He feels that having the American dollar as its official currency will restore investor confidence in San Miguel's economy and force fiscal and monetary responsibility on the part of the government.

Last year, the economy of San Miguel contracted 7 percent and inflation is currently running at over 60 percent.The San Miguel peso has lost 20 percent of its value in the past six months and foreign reserves are rapidly being depleted. It is hoped that by adopting the dollar as the official currency of the country, inflation will be eliminated, foreign investment will increase in the country, and economic growth will occur. The president is using the example of Argentina as his model;

however, he plans to go further than this neighbor did: Argentina now pegs its currency to the dollar on a one-for-one basis.The president's plan calls for San Miguel to slowly replace all its pesos with American dollars and only use its own currency for small transactions.All San Miguel pesos would be exchanged for dollars at a set exchange rate and all financial statements would be issued in dollars.No new national currency would be created. The idea has the support of the business community and the International Monetary Fund (IMF);

however, there is opposition from indigenous groups and others who worry that the plan would have an adverse effect on the poor.Others worry that such a plan would also remove some national sovereignty and put the United States in charge of monetary policy in San Miguel.At present both sides are strengthening their positions.The president and the business community are pushing for a rapid conversion and the opposition is planning demonstrations against the plan.There has been a call for work stoppages and mass protests on the part of the opponents.

The president dismisses the concerns of the opposition as foolish and points to Panama, which uses the US dollar as its currency. He states that Panama is a completely independent country with economic stability and that Panama is poised for strong economic development. San Miguel should learn from the Panamanian experience, states the president.

CASE DISCUSSION
1. How would replacing the peso with the dollar affect monetary policy in San Miguel?

2. What are the advantages and disadvantages of a country adopting the US dollar as its currency?

3. Other than replacing its currency, what else could be done to help solve San Miguel's economic problems?

4. What would you recommend?