The Almighty Dollar

Since 2000 Ecuador has undertaken a fascinating economic experiment that seems to be working out quite well. Following years of debilitating inflation (and correspondingly high interest rates) the country abolished their local currency and now solely relies on old-fashioned greenbacks straight from the USA.

1 - Plaza de Armas

Throughout South America, dollars are readily accepted and almost every cash register has slots for both the local currency as well as dollars. This is a holdover from periods of hyperinflation when the local currencies would undergo meaningful daily devaluations. Generally, the implied exchange rate makes it better to settle debts in local currency, but in some places (such as Uruguay and many hotels) price tags are in dollars and if you pay in local currency you will pay a premium. Ecuador has simply taken this a step further by eliminating the local currency.

2 - Presidential Palace

All the bills in circulation are imported from the US. Unfortunately, ones are in very short supply and many are quite frayed. If you were wondering what happened to all of those Sacagewea dollar coins that were minted a few years back, they are in Ecuador. The smaller coins are a mix of US and local, with the local being of slightly different sizes to (I assume) prevent them from being used in US vending and counting machines.

Overseas usage of dollars actually turns out to have tremendous benefit to the USA. The currency that each of us holds in our wallet is effectively an interest-free loan to the Federal Reserve. The fed uses this money to buy Treasury securities, which are (eventually) recycled back into the federal budget. (My understanding is that this process is not included in the official budget numbers. I assume this accounting treatment is done in order to avoid additional politicization of monetary policy.) Although we have trouble exporting cars at least we can sell our money. Of course, if global confidence in the dollar collapses, a lot of these interest-free loans may come due.

3 - Monastario de San Francisco

From Ecuador's perspective, dollarization offers the benefit of (presumably) a more stable currency and a drawback of a loss of control of monetary policy. When the fed sets rates, I doubt they spend much time considering the economic impact on Ecuador. On the other hand, Nebraska doesn't control its own currency either, and the fed probably doesn't spend much time thinking about the tiny sliver of the USA that supports the Cornhuskers.

In most emerging markets, the central bank actually doesn't have that much control over the economy because investors do not have much confidence that the bank will (can?) maintain the value of the currency (by avoiding high levels of inflation). Thus, the central bank will find it difficult to stimulate growth because investors will demand a premium (in the form of a high interest rate or return on investment) to hold the local currency. Alternatively, some countries have retained their local currencies but borrowed in dollars at lower interest rates. Inevitably this ends in disaster when the debt needs to be repaid (see Asian debt crisis of 1998 and Argentina circa 2001).

The other downside of using someone else's currency is that it tends to make you look like a banana republic (Ecuador, as the world's leading banana exporter, may be more comfortable with this moniker). I hope policy makers will make decisions based on more important factors than personal or national ego. Unfortunately, I am not very optimistic.

The left raised a number of other issues associated with dollarization, most of which struck me as being rather silly. (My sense is most liberals waver between a complete lack of understanding of central banking and paranoia that the whole subject is a rationalization for policy that somehow benefits wealthy capitalists at the expense of the downtrodden masses.) One argument against dollarization was that many natives spoke mainly Quechua, a bit (maybe) of Spanish and no English. How, the lefties wailed, would these natives possibly be able to read the English written on a dollar bill? Even if we assume that it is necessary to read more than the numbers (which tend to also be used in most other currencies), isn't it a bit condescending to think that these people are incapable of learning the word 'dollar'?

Traveling around Ecuador, the benefits seem obvious. The economy appears to be doing quite well. There is a strong middle class with excellent access to a myriad of consumer goods. The entire southern coast was dominated by mile after mile of tidy banana plantations. New construction is strong and we visited a couple of gleaming shopping malls that were absolutely packed with shoppers.

Quito itself is a quite attractive city with a beautiful colonial center. We have enjoyed exploring the city and had an excellent dinner in stylish restaurant on a mountainside above the city. If you travel through Quito, it is definitely worth spending a day. Next stop is Panama where we hope to pick up the Jeep. After four and a half months, farewell South America!

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