Is the Dollarization of the Cuban Economy Possible?

14ymedio, Elías Amor Bravo, Economist, 29 October 2019 — Since the Cuban regime authorized the new system of buying home appliances and car parts with hard currency and magnetic cards, Cubans once again feel a special attraction to the American dollar. Information from Havana  speaks of a spectacular increase in demand in the first days of this new measure.

Some data.

It could be said that in quantitative terms, the operation does not seem complicated. The current GDP of the United States, 19.39 trillion dollars, is 221 times larger than that of Cuba (87.73 billion dollars); that is, Cuba’s GDP is only 0.45% of that of the United States. Monetary absorption would be immediate.

If looked at from the perspective of the value of the GDP of individual US states,, Cuba would occupy the 36th position behind Nebraska and before New Mexico. In that case, it represents such a small fraction of the US economy that it seems negligible. Florida alone, for example, has a GDP of 754 billion dollars, eight times higher than that of the island of Cuba.

In absolute terms, the total dollars needed to finance the monetary circulation and transactions of the Cuban economy would be equivalent to those of a state like Nebraska, which, however, has a per capita GDP of $49,778 seven times higher than that of Cuba, which is only $7,602.

From a quantitative perspective, it would not be problematic to replace the currencies that circulate on the island with the dollar, in a massive conversion operation similar to that carried out in the European Union when it was agreed to establish the euro as a common currency.  But what the communist authorities would be willing accept is something else altogether, surely contrary to this process. The main difficulty of this is to establish a type of conversion that allows the Cuban economy to be competitive at the regional level, and I do not believe that the US would have any problem with this.

Bypassing the political obstacles, which are the most important, dollarization, under such conditions, would not be a quantitative problem, but a qualitative one. Because before establishing the dollar as a currency in Cuba and suppressing the other currencies, the variables of the fundamentals of the economy would have to be adjusted, and this requires determining what state they are currently in, what has been their recent evolution, and if it is possible to intuit what the dynamics may be in the coming years.

In that sense, the fundamentals of an economy include the qualitative and quantitative information that is essential to determine economic and financial well-being, and the consequent estimation of the value of the economy, having as its primary reference its currency.  And given that qualitative information implies the need to access elements that are not easy to measure, such as managerial experience or the qualifications of human capital, economists use quantitative information whose statistical or mathematical analysis is very useful for measurement purposes.

It is useless to promote the dollarization of the Cuban economy if there is no necessary convergence of the fundamentals with the US macroeconomic scenario, which, on the other hand, cannot be immediate, and which would demand different economic policies from today’s. If that convergence did not occur, the Cuban economy could break into a thousand pieces, and dollarization would not be a correct decision.

The truth is that the contrast between the main fundamentals of the two economies forces us to reflect. Basically because the distance is huge.

First, GDP growth in the US is currently around 3%, showing remarkable strength, while Cuba is inexorably approaching a recession, after announcing a growth rate of 0.5%, and probably even lower for this year. The difference in terms of growth is very relevant, and places the Cuban economy far from convergence. Either it grows more and more stable, or it is better not to make the move.

Second, inflation, which in Cuba cannot be estimated with comparative data, because its current consumer price index does not follow the rules used in international calculation. In this case, it should be approximated through the price index of the GDP deflator, a figure that has experienced an average annual growth from 2013 to 2018 of 3.5%, with notable inflationary tensions.  In the US in the same period, the inflation rate has stood at an average of 1.7%, or roughly half, which illustrates that the Cuban economy is at a considerable distance from any convergence process in terms of fundamentals.

Third, interest rates in Cuba are not determined by the market based on supply and demand, but are set by the government to finance the public deficit through debt issuance. The most recent data has interest rates at 2.5%. In the US, the Federal Reserve, autonomous in its monetary policy decisions in relation to the government, has set rates at 1.75% annually, which again displaces the Cuban economy from any convergence process, further separating its monetary conditions from those existing in USA.