Seigniorage Lost to Dollarization

Official dollarization has caused a loss of seigniorage in El Salvador, while the United States, in all its generosity through the Millennium Challenge Corporation and other aid agencies, is in reality lessening our loss of seigniorage because the United States, the issuer of the dollar we use, shares the seigniorage of the currency.

The country’s economy was dollarized on Jan. 1, 2001 via law-decree No. 201, titled the “Law of Monetary Integration” — LMI — passed on Thursday, Nov. 30, 2000.

This action of Francisco Flores Perez’s administration was taken without consultation and lay in the hands of the ad hoc Assembly Committee one week before its approval by the minimum amount of required votes.

From the removal of the colón to today, El Salvador has lost millions of dollars due to being unable to produce its own currency and therefore lose seigniorage.

“Seigniorage” is the profit obtained when a country produces money. It is the difference between the cost of producing the money and its value. For example, if printing a colón note cost 25 centavos, El Salvador would obtain a seigniorage — profit — of 75 centavos; that is, the difference between the cost of printing the note and its par value. This would be true if the note lasted forever, but as it lasts for a relatively short period of time, profit diminishes proportionally.

Seigniorage can be more fully understood with coins, which last much longer than notes.

When we adopted the U.S. dollar as legal tender, we immediately renounced the right to seigniorage.

Dollarization affects two types of seigniorage loss: first, the immediate cost to the money supply, given that as the dollar is introduced, the colón is removed from circulation and the Central Bank had to buy colóns on behalf of the public and banks, returning to them the right to seigniorage that had accumulated over time.

Second, the country loses the profits from future seigniorage gained by producing new money. That is to say, by no longing producing our own money, we no longer receive the seigniorage. Who receives it now? Quite simply, the U.S does, when it gives us its notes and currency from which it gains its own seigniorage.

It is estimated that foreign countries — dollarized or not — possess between 55 to 70 percent of the total value of notes in circulation, which implies that they are owed perhaps 15 billion dollar printing seigniorage per year.

In fact, the U.S. has recognized the domestic advantages presented by dollarization in foreign countries: They lose seigniorage by no longer producing their own money, while the U.S. gains it by sending its currency to countries that have dollarized their economies.

In the year 2000, the U.S. Senate passed the International Monetary Stability Act, proposed by Connie Mack, senator from Florida.

The idea of the law was to promote international monetary stability and share seigniorage with countries that had officially dollarized their economy.

The bill, proposed by the Senate Committee on Banking, Housing and Urban Affairs, would reimburse part of U.S. seigniorage to countries that dollarize their economy, 10 years after dollarization comes into effect.

The reimbursements would be financed by the profit that the Treasury Department would receive through the Federal Reserve System as a result of dollarization in these countries.

The reimbursements would be of up to 85 percent of extra seigniorage profits derived from dollarization in foreign countries.

The House of Representatives rejected the bill and it never became law.

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