The man at the Bundesbank (by tradition he wishes to remain anonymous) gestures with a grin towards a pile of official folders on his desk, each containing a letter from a concerned German citizen and awaiting his reply. "Dear Mr President Welteke," writes one Johann Public. "I am utterly dismayed to read in the press about plans to introduce the Deutschmark in Kosovo. Is this legal? If it goes ahead, I may well lose my faith in the Deutschmark and the euro."
In his habitually courteous reply, this Bundesbank economist will explain that, unlike in east Germany nine years ago, bundles of Deutschmarks will not be handed out free in Kosovo. US dollars or a lot of dinars will be needed to pay for them. And there'll be no bail-out clause.
By decreeing that the Deutschmark becomes legal tender in Kosovo, the UN administration in the war-battered province is simply accepting the status quo. The Deutschmark has been the street currency throughout Yugoslavia for decades, the principal medium for transactions of any real value. The dinar, which has lost 22 zeros in eight years, is good only for the purchase of local-brand cigarettes and Serbian newspapers. Now it will vanish from Kosovar streets altogether and the locals will be glad to see it go.
"There was no need for Kosovo to have its own currency, and no discussion about which currency should be used. The Deutschmark was manifestly desired by the Kosovar population," says Rutger Wissels, deputy head of the EU-led Economic Administration in Pristina.
New demand for the euro
That's textbook teaching: dollarization as economists call substitution of domestic currencies for a leading international currency, be it US dollar or Deutschmark is only for economic no-hopers, those one step behind the basket cases. That is why no-one objected to it in Bulgaria, Bosnia-Herzegovina and Montenegro, the other countries in the process of jettisoning their own currencies.
But over the past few months, the idea of abandoning the domestic currency in favour of the euro has gripped emerging Europe's more advanced economies. Even Josef Tosovsky of the Czech National Bank, Frankfurt's favourite central European central banker, is talking about it.
This new interest in other people's currencies reached Steve Hanke Wrst. Professor of applied economics at Johns Hopkins University, Hanke is a ubiquitous advocate of currency boards that's dollarization, but with local-issue notes and coins for countries from El Salvador to Argentina.
Suddenly, Hanke says, his answerphone in Baltimore was full of messages from central banks and finance ministries in Europe. "I thought the thing was dead until about a year and a half ago. I was on holiday in Europe and they started calling me. It took me completely by surprise," he admits. "What motivated this [interest] was the Asian crisis, then Russia in August [last year]. It wasn't even on the back-burner before then."
The next trigger was Argentina. In January president Carlos Menem, a close associate of Hanke, popped up with the idea that Argentina should give up the peso for the US dollar, thereby eliminating the risk of devaluation once and for all.
The start of Emu also demonstrated the benefits of abolishing exchange-rate risk. It's hardly surprising that other European central bankers should consider how to enjoy the same advantages.
By substituting their own currencies for the Deutschmark (in effect, the euro), countries in central Europe could take the concept of a currency-board system one step further, argues Charlie Robertson, emerging Europe economist at ING Barings. All notes and coins would be exchanged into Deutschmarks, and an exchange rate would be fixed for their currency against the euro.
Euroization would essentially eliminate the risk of devaluation (impossible without the reintroduction of a domestic currency), which in turn would facilitate trade and foreign investment. With interest rates down at euroland levels, consumption and investment would be boosted and a boom in local equity markets would surely follow.
In this way, Robertson says, central Europe could "jump the Emu queue". He believes that, with euroization, the convergence process could be accelerated by five to six years in the case of the Czech Republic.
Robertson offers a forecast of interest rates and inflation in 2001 to point out the diference between Euroland and central European countries and demonstrate the potential gains of euroization (table). Rather than waiting until 2006 at the earliest, the Czech Republic might join Emu within two years.
Robertson's analysis is "nonsense", spits an irritated European Central Bank economist. Admittedly, it's easy to pick holes by pointing out the possibility of a local credit crunch, demand-driven inflation, a selling spree on the country's government bonds and a selection of other evils.
But these fears are much less than the ECB's horrible imaginings. Admittedly, euroization might, just might, encourage a government to sort out its budget deficit, inflation and government debt to meet the Maastricht criteria more quickly. And because it would speed up convergence so dramatically, euroization actually requires more discipline than the existing economic targets for these countries. The problem is that any promise to use self-discipline would have to be taken on trust.
The ECB's horror scenario is that a country might try to use euroization as an excuse to fudge convergence and try to make a forced entry into Emu before meeting the Maastricht criteria. That's exactly the point, says Hanke, confirming those fears. "If they'd already converged, why would they want a currency board?"
Moreover, that country might use its de facto Emu membership to get credit from banks. The ECB would certainly refuse to inject liquidity in times of crisis, but Robertson points out that commercial banks might be happy to extend credit to the government in return for a stake in a nationalized company or even for a better relationship. That already happens in Panama because it is a dollarized economy.
These are new ideas that go beyond the Bundesbank's traditional arguments. For years, the Bundesbank's main objection has been that excessive use of the Deutschmark in foreign economies would make it more difficult to monitor M3, the main economic indicator used for German monetary policy.