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The Dollarization of World Trade and Its Impact on Cambodian Economy


IRP can be an essential part of IS 305 Global Governance course. With its aim to address each student's understanding a particular problem of global governance in highly relevant to Cambodian current affair and its important devote the course's examination, I've paid tremendous amount of time focusing on each MC as well as the ultimate MC.

Among all the topics suggested, I've chosen the 6th issue:"The Dollarization of World Trade and its own Impact on Cambodian Economy" This specific topic is related to economical as a course theme of global governance. Apparently, economic is an interesting and essential theme which gets increasingly more reputation in global governance. Global governance is a sophisticated interplay among many themes or templates whose one which is monetary.

On top of this, I've chosen the aforementioned issue as my IRP subject for two major reasons. To begin with, this subject is personally appealing to me. I've seen other neighboring country with better economy utilizing their national money so widely. In contrast, in Cambodia US money is more preferably accepted throughout the whole country. This is actually only a brief part of the history since dollarization started to disperse worldwide after WWII ended. I want to discover more about the causes and ramifications of this happening on the small economy of Cambodia. I am also willing to learn about the have difficulties of local government and other IGOs to govern the impact of dollarization. Last but not least, this issue allows me to demonstrate the intersection of global governance with the US among the most powerful players in international area as well as the role of IGOs, style of trade globalization and global governance, and even the response of Cambodian federal on regulating the impact of dollarization on Cambodian market.

I have divided my IRP into five main parts where each aims to handle different aspect of "dollarization trend".

Part I: Triggers and Development of Dollarization of World Trade

International recognition of the foreign currency in world trade is not a brand new happening. During the eighteenth and nineteenth ages, the pound of Great Britain reigned as the first reserve money on the globe, but in the twentieth century, the U. S. dollar laid case to this title. It includes since been the dominating reserve currency because the end of World War II.

Definition of Dollarization

To fully understand the impact of dollarization on Cambodian current economic climate, step one is to specify what dollarization is. Most to put it simply, Dollarization means adopting the US dollar as the money of preference in a overseas country. However, dollarization's definition does not end here. Dollarization is a general term that can get caught in three categories:

Official Dollarization: The buck is the one legal tender. In other words, there is no other local currency. Instances are that in Panama, El Salvador and Ecuador. For example, since independence in 1903, Panama has only used the U. S. buck.

Semi-Dollarization: A country use both its money and the U. S. dollars interchangeably as legal sensitive. Lebanon and Cambodia are good examples of this.

Unofficial Dollarization: For many countries in the expanding world, the money will be trusted and accepted in private transactions, but it is not labeled as legal tender by the country's federal.

Official dollarization occurs usually in small or producing countries. Countries that normally choose such a radical change in financial policy are often encountering instable economies, high degrees of inflation and an extremely low competitive money. Under formal dollarization the local currency is completely substituted by the dollars, with the possible exclusion of coinage. That means domestic banking companies only accept buck verifying accounts and concern dollar loans. National Reserve notes are legal sensitive and the only form of newspaper money recognized by the government.

In the truth of Semi-dollarization, just as Latin America and in the previous Soviet Union, where in fact the purchasing ability of the neighborhood money has been volatile and people put more confidence on foreign currency, people often carry us dollars as a store of value. In those situations the domestic currency is commonly used in small transactions, however the dollar is preferred in large ventures and in savings.

It should be pointed out that although many people associate dollarization with the U. S. dollar, the connection is not exclusive. Dollarization may more and more refer to alteration to other currencies including the Euro. Besides, South African rand, Russian ruble, New Zealand buck and Australian money are also accepted outside their countries, although in a localized character. For example, the Russian ruble is accepted in a number of the countries from the old Soviet Union. Thus dollarization might not exactly solely make reference to US Dollar. Despite this, in this MC as well as IRP, I will exclusively speak about US Money to web page link it with the truth of

dollarization in Cambodia. Dollarization, in this sense, differs from economic union because the united states continues to create monetary insurance plan in its interest by itself, whereas the Western european Central Bank must take all Eurozone countries' pursuits into account.

Origin of Dollarization in World Trade

The source of dollarization rooted back again to the Bretton Woods Arrangement. In the aftermath of World Warfare II, US dollars was the only major currency in which international exchange could freely take place thanks to its relatively secure value while all other European's big economies were shattered due to the warfare. The dollar's role was formalized under the 1944 Bretton Woods monetary agreement, a global arrangement to govern economic policy among nations. Other nations set standard exchange rates contrary to the dollar, while the US decided to exchange us dollars for silver at a set price on demand by central lenders. It had been an opportunity to build a stabilizing international money and ensure monetary stability once and for all. The Bretton Woods Agreement also had the purpose of rebuilding after World Conflict II through a series of currency stabilization programs and infrastructure loans to war-ravaged countries. By 1946, the machine was in full operation through the newly established International Loan provider for Reconstruction and Development (IBRD, the earth Lender) and the International Monetary Account (IMF).

It is also important to notice that the United States had 80 percent of the world's silver reserves at that time. So the USA had every motive to consent to the utilization of the rare metal standard to organize world currencies and to create and encourage free trade.

This system functioned well for a limited period. However by about 1958 the initial worldwide dollar scarcity had turned into an overabundance. As only platinum and the U. S. asset were considered significantly as reserves, when gold production was lagging, buck reserves was required to expand to constitute the difference in lagging gold availability, causing an evergrowing U. S. current profile deficit. The Bretton Woods agreement collapsed in 1973.

As it is seen, the actual results of the Bretton Woods Contract was to displace the rare metal standard with the dollar standard, which is the origin of dollarization on the planet.

Growth of Dollarization

Following the origin of dollarization, it's important to have a closer take a look at how money grew and the reason why behind it.

After World Battle II ended, the united states ran large current consideration surpluses as the war did not deal with on its land. As the largest economies on earth, the united states also aimed to have the strongest ideological electricity, democracy. During Cold War period, to be able to deter communism in European Europe, the united states initiated the program famously known as the Marshall Plan. Through this, American financial aid emerges for a program of European economic restoration. During its 3 years of living, 1947-1951, the US spent almost $12, 500, 000, 000. The consequence of this is a accumulation of dollar belongings by foreign firms and central lenders.

Another cause of the growth of dollarization is that the rapid development of the industrialized economies after World Warfare II created a growing demand for money balances surrounding the world. The greater of its own currency a central bank issued, the greater dollars it sought as underpinning for its currency.

Besides these past reasons, US dollar possesses some spectacular characteristics that made it the currency of preference. Balance is one of the major factors that talks about why lots of countries have adopted the U. S. buck as official money. With North american both monetary and military services might, the U. S. dollar hasn't been devalued nor invalidated. This feature of dollars makes countries with uncertain financial situation all acquainted with lender failures, devaluation and inflation, has a serenity at heart by adopting and enjoying the great things about the stableness of the U. S. dollars.

As it is mentioned, similar to official dollarization, unofficial dollarization is also very hard to invert once it is set up. As unofficial dollarization also can take root in countries with unpredictable and weak overall economy, only certain plans and remarkable countrywide economic development will invert the trend, and this will not happen frequently.

Dollarization Today

As of nowadays, dollarization is clearly seen. As of the start of 2000, 28 countries and territories have officially dollarized, and countries with unofficial dollarization are numerous. Over half of all dollars notes in circulation are held outside the borders of the US. About half of US Treasury securities are owned by foreigners, mainly placed as reserves by foreign central banking companies. The dollars is the key currency in international capital moves, as well as the money of invoice for commodities and for most made goods and services. All countries that trade straight with the united states invoice both imports and exports in US us dollars.

Part II: Record of Dollarization in Cambodia

This part is going to discuss the primary explanations why Cambodian economy is dollarized by giving evidences as well as my very own analysis. It will also about the present situation of semi-dollarization in Cambodia. This part crucially contributes to the Individual Reflection Paper since a knowledge of the complexities as well as the situation of Cambodian dollarized economy is vital to studying the responses to the phenomenon.

How Dollarization Took Root in Cambodia

Dollarization in Cambodia occurs mainly to several main reasons. I organize each cause matching to their formality.

Firstly, Cambodian folks have lost a major trust on local money, Riel, after it was completely abolished through the Pol Pot regime. Cambodian people have bitterly seen all the personal savings that they had in Riel become just scraps of newspaper in a single day. Almost, Cambodia is the one country on earth ever to get abolished money. This radical test, which kept Cambodia being with out a money from 1975 to 1980, has still left its symbol on Cambodian people conception today. In March1980 Riel was once again unveiled as the countrywide money in Cambodia. However, significant central bank financing of recurrent budget deficits during 1988-1991 resulted in high inflation in the number of 90%-177% each year. This further eroded general population assurance in the countrywide currency. Because of this, but the reissued Cambodian riel has been around circulation for three years, Cambodians remain distrustful than it and regularly convert their riel into silver, jewelry, or U. S. dollars instead.

The second reason links to the peacekeeping procedure performed by the United Nations from 1991-1993. During this period, millions of Dollar were poured into Cambodia each year. With tremendous amount of Dollar in flow and a big quantity of Cambodians started out using Dollars, Cambodia's economy became effectively dollarized. All together, since most people still tried to protect their own resources, they sold their riel-denominated investments in exchange for silver in the first phase and for the money in the second phase. They got stuck with us dollars afterward.

Thirdly, the reason why may rest on the nature of Riel itself. Riel, compared to dollars, is less simple to use for large deals. Ten US dollar monthly bill already similar in at least four ten-thousand Riel charges. The government steadily has introduced much larger denominations, but these expenses have not come into common usage. On top of that, since the release of Riel in 1980, Riel has seen ongoing depreciation which subsides Cambodian people' determination to store it as an asset. From the first time Riel was reintroduced in 1980 as yet, value of Riel has gone down for 1000%.

Last however, not least, dollarization in Cambodian may link to Cambodian people understanding. Most Cambodian views Dollars as the demonstration of wealth and style which leads to certainly high Buck usage in urban area. A straightforward example can be seen. Top quality restaurants and boutiques in Phnom Penh all have their price labeled in dollars whereas smaller retailers still involve some tendency to work with Riel. As much, in sophisticated work area, Dollar is utilized rather than Riel, as people becomes richer, they'll automatically convert the use of Riel to that of Dollars, thus carrying on the Dollarization pattern.

Current Situation of Dollarization in Cambodian Economy

Although Cambodia is still a country with semi-Dollarization, Money is trusted throughout entire Cambodia, and the ratio of Dollar consumption is incredibly high in urban area.

In 1998, the National Loan provider of Cambodia, or Central Loan company, conceded that it was struggling to account for the volume of forex in circulation. Loan company officials believed it exceeded their official gures, plus they approximated that the U. S. money was probably 3 to 4 times more liquid than the riel. 8

The following years have observed the progress in bank sector in Cambodia, and the habit banking first deposit and lending has greatly increased. In 2005, bank deposits grew by about 16% with the upward trend carrying on into 2006, reflecting better self-confidence in the bank operating system. Despite this positive indication, the talk about of the riel in these areas has been only 4% and 6% respectively, indicating the highly dollarized characteristics of Cambodia's market. Quite simply, the ratio of Riel debris has grown by just 2% from 1990 until 2004.

Although Cambodian specialists want to encourage better use of the nationwide currency, they may have emphasized that they have no intention of imposing limitations on the utilization of foreign currency. They on the other hand believe the use of the riel will develop as an outcome of monetary development. Nowadays, the exchange rate system consisted of two rates: the state rate and the parallel market rate.

Part 3: Costs and Great things about Dollarization in Cambodia

The high amount of dollarization in Cambodia has played out a major role in shaping Cambodian's economy. It brings about many benefits to the tiny Cambodian overall economy which just started out from the zero-point thirty years ago and whose goal is usually to be integrated in to local or even global current economic climate. However, along with benefits, high dollarization also poses an issue to Cambodian overall economy. This newspaper will quickly present these entire issues.

Costs of Dollarization to Cambodian Economy

There are certain costs brought on by high dollarization in Cambodia. First and most evidently, high dollarization helps it be hard for administration to conduct completely effective monetary regulations. With any procedures government makes, high degree of dollar positioning in Cambodia will impede the policies to be completely implemented and therefore undermine its performance. These policies are the management of money resource, interest rates, and also to some extent the exchange rates. Due to high dollar first deposit in bankers, the role of National Standard bank of Cambodia (NBC) as lender of last resort for lenders facing liquidity problems is also greatly constrained. The high degree of dollarization restricts the overall flexibility of exchange rate insurance plan to deal with external shocks. For example, the increase in world olive oil prices in 2005 was followed by inflation in Cambodia. The inflation rate rose between 9% and 10% in just a few months.

Secondly, government's income from seigniorage is reduced. Seigniorage, to put it simply, is the difference between the value of money and the price to create it - in other words, the economic cost of creating a currency within confirmed current economic climate or country. The amount of loss is quite significant as the web gross annual income forgone is approximated to maintain the range of $20 million to $90 million.

Another cost is that dollarization can lead to currency mismatches. This happens to businesses or business whose income is in Riel. As a high amount of first deposit in Cambodia is within dollar, these businesses and businesses may need to take on dollar-denominated debts because that is the only way to get longer-term loan. On this sense, in the event of a large devaluation of Riel, such businesses and businesses may find themselves at great lost and are unable to service their personal debt. Although this problem occurs and then small number of firms, this is also a challenge of dollarization.

The last drawback of high dollarization deals with the real role of Riel. Under such situation, Riel may only stand as symbolic of sovereignty and nationwide identity and will not play a complete role throughout the market. This isn't a good idea since the icon of national identification is not sufficient for a nationwide currency.

Benefits of Dollarization to Cambodian Economy

Despite above costs, dollarization also brings about remarkable benefits to Cambodian economy. First of all, the advantages of buck during UNTAC operation in 1990s has helped Cambodian visitors to convert their possessions from platinum to dollar and consequently made money deposit in finance institutions easier and since incentive to place savings overseas was taken out, this encouraged domestic financial intermediation to flourish which resulted in the progress of the economic climate.

Secondly, dollarization reduces the risk of Riel devaluation. Because of high degree of buck circulated in Cambodian economy, the demand for Riel remained low. With this low demand, the NBC will not unnecessarily print out more amount of Riel. Very high dollarization in Cambodia is therefore led to low inflation and economical stability.

Thirdly, dollarization makes Cambodian current economic climate more stabilized. The diminished risk promotes both local and foreign investors to invest money into Cambodia. Currency balance promotes macroeconomic steadiness and a predictable business environment. Evidently, high amount of dollarization secured Cambodia against contagion when confronted with the Asian financial meltdown of 1997-1998.

Last but not least, the use of the dollars facilitated the integration process of Cambodia's trade in the international market. It reduced the business deal costs by omitting currency conversions cost. Besides, it also enabled the growth in the garment industry in Cambodia.

Part 4: Role of Cambodian Administration and International Celebrities on Reducing the Impact of Dollarization

Having been exposed to the expenses and benefits associated with high dollarization, it is essential to take a further step to determine what the position of Cambodian federal is and what it did so far to help make the best out of this situation. Accompanied this, the role of other international celebrities regarding dollarization's impact issue may also be discussed and provided.

Cambodian Government's Policies

To begin, it is important to understand that in Cambodia, your choice maker regarding monetary insurance plan is the National Standard bank of Cambodia (NBC). NBC is autonomous from the government and authorities cannot hinder NBC's monetary plan decision. However, to make it simplified, I'll merely use the term "Cambodian federal government" along with "NBC" in conditions of financial policy's decision machine.

So very good, NBC has taken good thing about dollarization in Cambodian overall economy to stabilize inflation rate and acquire a favorable exchange rate. As government-backed securities such as treasury expenses and authorities bonds do not exist in Cambodia, buck serves alternatively for the Open-Money Operation (OMO), one of the conducts of economic policy to regulate money supply and therefore inflation rate. To illustrate, OMOs are defined by National Loan company of Cambodia (NBC) as operations to purchase or sell dollars against the riel with the aim to stabilize the fluctuation of the exchange rate between your two currencies. With dollar, NBC can manipulate the inflation rate to an appealing level and therefore achieve price balance. History shows that dollar auction has been a highly effective tool to adapt the exchange rate.

Although dollar takes on an important role in OMO in Cambodia, the best goal of Cambodian administration continues to be to raise the role of riel in economy and make it greater than a mere sign of sovereignty. Various steps have been taken by the NBC regarding de-dollarization strategy. Most of all, for macroeconomic guidelines, NBC aims on maintaining the steadiness of exchange rate and low inflation rate, while regarding legal reforms, NBC has set a set amount of riel as reserve requirement ratio for bankers. However, these steps have been insignificant therefore have been the effect. This is probably because of

the current situation of Cambodian market, whereas we will discuss this problem more deeply within the next part.

Role of Other International Actors

In money affairs, the necessity for more assistance is urgently pronounced since apparently harsh decision of 1 state's monetary insurance policy can draw types of external results that exceed the number state's territory, and that a unilateral response is not desired. Contrastingly, despite having ask more co-operation in international financial coverage among great capabilities, monetary insurance policy still rests mostly on individual talk about to decide.

On the national level, regarding dollarization concern, it is obvious the US National Reserve has not taken into account those countries that are officially dollarized, not to mention unofficially dollarized countries like Cambodia. The Given has explained that it would never act as a lender of final resort to foreign finance institutions, nor would its financial policy be contrary to the best interests of the united states. Thus, dollarized countries have to carry their own cost and discover appropriate policies to deal with it. Up to now, US Given has used a neutral position, neither encouraging nor discouraging dollarization.

On the international level, there has been more sign appealing for assistance. However, even with more cooperation, it still strains only on major money such as dollars, euro and yuen, whereas economy for small states like Cambodia is disregarded. Thus, main decision still rest with Cambodian federal about how to steer for a blessing environment because of its currency. Not surprisingly fact, we ought to all remember that, appealing or not, any decision made by the US Fed to understand or depreciate its money will make the result be noticed in Cambodia who's highly dollarized.

Part 5: Future Response of Cambodian Government: Dollarize or De-Dollarize

High dollarization in Cambodia has blessed the market with balance and progress. However, even with increased economical and political steadiness, dollarization has been consistent which is wii sign for a wholesome economy with its national money. The National Loan company of Cambodia has used procedures to eventually de-dollarize and improve its electric power over monetary plan, but the realization of the goal continues to be quite a distance to go.

Why Cambodia Should Stay Dollarized and just why Cambodia Should De-Dollarize

As expressed in the previous part, high dollarization has taken about significant advantages to Cambodian current economic climate. Dollarization, for example, helps maintain low inflation rate, and because of this also steady exchange rate. The Open-Money Procedure (OMO), one of the conducts of monetary policy, purely speaking, do not exist in Cambodia scheduled to a lack of government-backed securities such as treasury charges and government bonds. However, OMOs are defined by National Standard bank of Cambodia (NBC) as operations to buy or sell us dollars from the riel with the objective to stabilize the fluctuation of the exchange rate between your two currencies. With dollars, NBC can modify the inflation rate to a desirable level and thus achieve price stableness. Since 2005, only NBC has the legal rights to execute the dollar auctions, and history has shown that dollar auction is really an effective tool to modify the exchange rate. Besides, dollarization also helps the integration of small Cambodian overall economy with the rest of the world by reducing transaction charges for purchasing international money.

Despite the aforementioned factors, it continues to be convincing for Cambodia to de-dollarize because of some reasons. Most seemingly is the fact that NBC cannot manipulate the flexibility of its monetary policy due to advanced of dollar blood circulation in the economy. As illustrated in 2005, inflation increased between 9% to 10% in just a few months due to the rapid upsurge in the world oil price. Also, any minor change around monetary policy can have effect on Cambodian market as well. Besides, high dollarization also limits Cambodia's effort to maintain a money value beneficial for export since dollarization hinders price-wage versatility. Last & most significantly, de-dollarization is an indicator of growing and healthy overall economy. For Cambodia to keep depending on forex is not a advantageous choice to make. Mainly, de-dollarization provides about a important national currency as well as a powerful and effective monetary insurance policy tool to impact the national overall economy.

Possible Solutions

Besides what Cambodian administration has done up to now, there are some recommended policies that could be done to strengthen the de-dollarization process. Firstly, the NBC begins refinancing lenders with Riel limited to functions conducted in Riel. This is a remarkable move. Second, NBC must make operations in Riel more getting compared to dollars in the bank operating system. This include, for example, making the interest rate of Riel-denominated debris higher than that of the buck. Another way is to develop a fresh financial devices denominated in Riel such as treasury expenses, and these charges have to offer higher produces for the compensation for exchange rate hazards. Lastly, there has also been encouragement for Cambodia to adopt a Currency Mother board Arrangement (CBA). Creating CBA methods to peg the nationwide currency to another currency. If so, NBC can only just issue a degree of Riel that is fully backed by overseas assets at preset exchange rate, which in the case of Cambodia would be naturally dollar. By adopting a fixed exchange rate, a successful CBA would allow Cambodia to de-dollarize as well concerning maintain continued economic stability for financial progress. However, Cambodia would need substantial international reserves to be able to sustain the amount of money in blood flow.

Remaining Challenges

Among all the envisaged solutions, there continues to be left with one impressive task Cambodia must triumph over to make the above policies effective. This challenge is usually that the NBC must ensure exchange rate balance and macroeconomic stability so that private industries will gain self-confidence that you won't be penalized for possessing riel-denominated assets. Ensuring exchange rate steadiness and macroeconomic stability requires time, effective work as well as continuing healthy market, thus the success of de-dollarization continues to be in the very good future to come for Cambodia. As shown nowadays, interest for Riel-denominated debris is already higher than that of the Dollars, but public opinion still place their assurance in Dollar and the percentage of Dollar-denominated deposits is still higher than that of Riel.

In finish, Cambodia should de-dollarize its overall economy, just like just what a country with a healthy economy would do. However, given the unresolved issues, the de-dollarization of Cambodian overall economy continues to be a long-term goal. These issues may increase as Cambodia gets exposed to more capital flows from FDI in dollar which makes it even more difficult for the NBC to accomplish its ultimate goal. Together with renewed investment, more tourism receipts, the starting of financial market and increased financing in buck can all donate to more dollar flow.

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