More on the nominal strength of the dollar

Adrián Lucardi writes to me, addressing yesterday’s question of why more currencies are not nominally stronger than the USD:

Short answer: costly to implement; few direct (political or macroeconomic) benefits if things go well; but politically costly if things turn sour.

Long answer: Suppose you’re the dictator of a non-serious country who wants a “strong” local currency for propaganda reasons. The dollar is probably more valuable (nominally) than the local currency, so you will have to start with a massive currency reform. This is costly (bad) but will increase the salience of the issue (good, you’re doing it for propaganda reasons). But then, you make the exchange rate focal: you publicly commit to it as a signal of your government’s performance. Since you’re unlikely to keep your currency more “valuable” than the dollar in the medium term, this can be disastrous.

Furthermore, since your commitment to a “strong” exchange rate is not credible, people may use the local currency to buy dollars. This may not be rational in the sense that the local currency is only “strong” in nominal terms, but if everybody believes that everybody will do it, the logic becomes self-fulfilling.

PS. Non-serious governments have long used exchange controls to benefit cronies and politically valuable constituencies. But if you’re doing that, you don’t want the exchange rate to be in the public imagination.

Our own Alex T. writes:

Coins are expensive to mint. Poorer countries are thus more likely to use fiat currency for smaller denominations and so must be “cheaper” than US dollar.

A nice virtue of this story is that it is testable.

Both points are of interest for those who have been paying attention to the difference between real and nominal currency values.


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