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Ecuador: Greenback Magic? (Int'l Edition)


International -- Latin America: Currencies

Ecuador: Greenback Magic? (int'l edition)

Quito's plan to dollarize renews debate in other Latin nations

A team of U.S. officials arrived in Quito on Feb. 28 to discuss with Ecuador's government its plan to adopt the dollar as the country's official currency. Ecuador's decision to swap the sucre for the greenback has rekindled a long-running debate over dollarization in Latin America. Panama has used the dollar since 1903. Argentina and Mexico have flirted with the idea in the past couple of years. And experts believe other Latin nations, such as Venezuela and Peru, would be better off with the dollar.

It's a controversial topic that can get nationalist politicians--as well as economists--excited. Advocates of dollarization, mostly academics and executives, argue that nothing beats the greenback for quickly bringing down inflation and interest rates in unstable economies. Adoption of the dollar also eliminates currency risk, or the threat of a devaluation, thus encouraging investment.

Opponents argue that dollarization is a straitjacket since countries must surrender control of monetary policy to the U.S. Federal Reserve. That could spell trouble for nations whose economic cycles are not in sync with those of the U.S. For example, the Fed's decision to notch up interest rates to cool growth in America would have a negative impact on a dollarized foreign country that needs to stimulate growth.

Many Latin American policymakers and political leaders are leery of the loss of national sovereignty that dollarization implies. "You lose not only the ability to make monetary decisions but also some of your identity," says former Brazilian Finance Minister Mailson da Nobrega. The U.S. is also ambivalent about dollarization: It can't prevent it, but it does not promote it, either.

Dollarization is not difficult to pull off. As a first step, the local currency must be pegged to the greenback at a fixed rate. Then the local currency is swapped for dollars held in reserve at the central bank. In time, the local currency disappears.

Panama had it even easier. It chose to go with the dollar rather than mint its own money when it declared independence from Colombia a century ago. Thanks in large part to the greenback, Panama has been a model of economic stability for most of the past four decades, with inflation averaging just 1% a year in the 1990s. Liberia, along with a handful of tiny Pacific islands, are the only other countries that use the dollar as legal tender.

Mexico has also given some thought to dollarization. Business leaders, especially managers of big companies that have large dollar revenues from exports and dollar-denominated debt, have urged the government to consider the greenback since 1998. So far, though, the Mexican government has been cool to the idea, arguing that the free-floating exchange rate is one reason the country has been able to weather financial turbulence emanating from Asia, Russia, and Brazil. Yet Carlos Slim, chairman of Telefonos de Mexico, believes dollarization "will happen at some point" because the Mexican and U.S. economies are becoming ever more intertwined.LOST MOMENTUM. Argentina has even stronger reasons to switch to the dollar. Its currency board pegs the peso to the dollar at a one-to-one rate, and dollars already circulate freely. With the economy under severe pressure after Brazil's devaluation last year, then-President Carlos Menem proposed that the country adopt the dollar.

But the idea has lost momentum since Menem's successor, Fernando de la Rua, took office in December. That's too bad, says Guillermo Calvo, director of the Center for International Economics at the University of Maryland at College Park, since for Argentina, "there is no advantage to having its own money." Confidence in the Argentine peso is shaken every time an emerging-market economy suffers a crisis or "whenever someone like George Soros wakes up in the morning and says maybe the peso is overvalued," notes Calvo. That's dangerous, because most Argentine companies have dollar debts. A devaluation would therefore wipe out scores of businesses.

The same could happen in Peru, where business is often conducted in dollars. For Peru, dollarization is a "no-brainer," says Michael Gavin, Latin America economist at Warburg Dillon Read. The greenback already makes up 70% of private bank accounts. Analysts say Venezuela, with its chronic high inflation, could also benefit from going over to the dollar. Yet the subject has not come up for serious debate in Caracas or Lima.

Chile and Brazil have not warmed to the idea of trading in their currencies for the greenback, either. Both moved over to floating exchange rates last year, and that has served them well so far. Interest rates in Chile are already low, at around 5%. Rates also have been coming down in Brazil since the devaluation of the real in January, 1999, thanks to the central bank's skillful management of monetary policy. The two countries would probably have to undergo a major financial crisis before dollarization would become a topic for discussion."COINCIDENCE"? It took an economic cataclysm for dollarization to surface as an option for Ecuador. The local currency has shed more than two-thirds of its value in the past year, causing inflation to soar to an annual 60%. Still, then-President Jamil Mahuad's announcement on Jan. 10 that the country would be swapping the sucre for the dollar took everyone by surprise. Less than two weeks later, Mahuad was ousted by an army-backed coup. Although his successor, Gustavo Noboa, aims to see the plan through, success isn't guaranteed. "Ecuador has so many problems that if dollarization works, it would just be a coincidence," says Sebastian Edwards, an economics professor at the University of California in Los Angeles.

If dollarization fails in Ecuador, it could discourage other governments from trying it. That would be fine by Walter Molano, head of economic research at BCP Securities in Greenwich, Conn., who believes dollarization is no substitute for reform, particularly in nations with profligate public sectors. "Lack of fiscal discipline gets countries like Ecuador into a mess," says Molano. Panama has often run big budget deficits, a reminder that the dollar doesn't stop governments from overspending.

Although advocates of dollarization believe it can help even stable economies, the idea gets most attention in troubled times. In the short term, only small and weak economies, such as Ecuador's, will switch to the dollar. But calls for adopting the greenback could grow stronger in coming years as trade links between Latin countries and with the U.S. multiply. For now, the debate rages on.By Ian Katz in Sao PauloReturn to top


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