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Ecuador Dollarization: Anchor in a Storm

Dollarization has provided Ecuador with the longest period of a stable currency in a century, but is now likely on its way out.

BY PEDRO P. ROMERO 

Since 2000, Ecuador has had five governments and 16 ministers of finance. The country has always been politically volatile. What has distinguished this decade from previous ones is that political volatility has not translated into currency instability. The reason is that Ecuador adopted the U.S. dollar as its official currency in January 2000. But now the dollar is coming under threat, not because it doesn’t work, but because it works too well, running contrary to the President Rafael Correa’s attempt to gather as much power as he can into his own hands.  

For Americans, it is hard to imagine what Ecuadorians suffered through in 1999 as the national currency, the sucre, experienced a vicious cycle of devaluation, inflation, and further devaluation. Low-skilled workers ended up earning no more than $8 a month. Even higher-skilled workers in the service sector earned no more than $40 a month. People with easy access to foreign currency could protect themselves from the calamitous erosion of their purchasing power, but most Ecuadorians could not. 

EGALITARIAN POLICY

Dollarization put an end to the vicious cycle by burying the sucre. It was the most egalitarian policy that Ecuador has adopted in the last few decades, because it was the marginalized who suffered most from inflation and devaluation. Even so, it received a skeptical reception. At the time, IMF head Michel Camdessus said, “Dollarization was not, I must be frank, the kind of policy we would have recommended at this stage to Ecuador.” Paul Krugman compared it to witchcraft and thought it would leave the economy dead. Sebastian Edwards of UCLA said, “Ecuador has so many problems that if dollarization works, it would just be a coincidence.” 

Nine years later, one cannot dismiss the survival of dollarization as coincidence. Dollarization has provided Ecuador with the longest period of a stable, fully convertible currency in a century. Its foremost result has been that inflation has dropped to single digits and remained there for the first time since 1972. The stability that dollarization has provided has also helped the economy grow an average of 4.3 percent a year in real terms, fostering a drop in the poverty rate from 56 percent of the population in 1999 to 35 percent in 2008. As a result, dollarization has been popular, with polls showing that more than three-quarters of Ecuadorians approve of it. 

However, a monetary system can only solve monetary problems. Ecuador has other problems that the government is neglecting or even creating. Economic recovery under dollarization and the world oil boom enabled the government to vastly increase spending, which has almost quadrupled since 1999. Despite all that money, the government projects a budget deficit of 3.3 percent of GDP this year. Unlike its neighbors, Ecuador did not save for difficult times. Mr. Correa’s decision last month to default on debt owed to foreign private creditors, despite adequate resources to pay, locks the country out of foreign capital markets.  His willingness to break contracts with foreign companies and his hostility towards private enterprise in general discourage investment. 

CORREA CRITICAL

From the start of dollarization, Mr. Correa’s attitude about it has been vehemently critical, verging on hatred. Until now, economic growth and the popularity of dollarization have safeguarded the system. When I returned to Ecuador recently, though, few people I spoke to expected dollarization to last past the middle of this year. They think Mr. Correa will use the worldwide recession, which is now also affecting Ecuador, as a pretext for reintroducing a national currency. A recent rewriting of the constitution—the 20th since 1830—eliminated the independence of the central bank, which now issues no currency other than dollar-denominated coins. If Ecuador reintroduced a national currency, monetary policy would be completely under Mr. Correa’s control. 

And yet, Mr. Correa’s own survival in office probably depends on dollarization more than he realizes. Ecuador lacks a reliable political system, legal system, or investment climate. Dollarization is the only government policy that provides Ecuadorians with a trustworthy basis for earning, saving, investing, and paying. Nobody would trust a new national currency; the historical record is too bad and the institutions to support it are too politicized. Rather than promoting stability, a new national currency would instantly destabilize an already troubled economy, perhaps even generating enough discontent to fuel popular protests of the kind that have driven two of the last five presidents out of office. 

Pedro Romero, an Ecuadorian, is a Ph.D. candidate in economics at George Mason University. He wrote this column for Latin Business Chronicle.

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