Ecuador’s history and geography are filled with interesting facts and landscapes. For instance, the government in the mid-19th century had plans to settle with its creditors by giving them the Galapagos Islands, considered worthless after the failure to find any guano there. Other curiosities include the fact that Ecuador holds the western-most point of the continent: the Peninsula de Santa Elena that juts out into the Pacific Ocean. Of more recent historical importance is Ecuador’s boast to be the first country independently to adopt a foreign currency and eliminate its own. The process, known as dollarization, may be the monetary equivalent of Costa Rica’s elimination of its armed forces, and has certainly placed Ecuador at the forefront of monetary discussions everywhere.
The fact is that no country can have a sound economy without a sound currency. Money is the foundation – the basic building block – which entrepreneurial activity needs in order to function correctly. Without a sound monetary system, economic calculation is hampered and capital, labor and all factors of production are waylaid into less efficient production. This is precisely what Ecuador avoided when it dollarized: it bought a stable currency. Not just any stable currency, but a universal currency as well: the US dollar. The distinction between simply stable and universal is important. The Honduran quetzal and the Chilean peso have been stable currencies for many years, but you can’t use them to settle many international transactions. Stability is not sufficient on its own to give a currency worldwide acceptance.
Ecuadorian currency did have a brief period of wide international acceptance, however, and it happened on or about the time its government officials were debating whether or not to give away the Galapagos. In Herman Melville’s 1856 masterpiece Moby Dick, an Ecuadorian doubloon is offered as a reward for the first sailor to spot the famous white whale. Of course, at the time the world currency was gold, so its universal acceptance should not come as a surprise. But out of all the currencies in the world, Melville chose one from Ecuador on which to write a whole chapter of his book.
Current economic growth in Ecuador is another interesting fact. In 2001, the economy grew by 5.3% and, according to the IMF, it is poised to grow this year by about 4%. This makes it one of the fastest-growing economies in Latin America, and in the world. Petroleum and dollarization are among the most important roots of this economic growth.
Ecuadorian dollarization should have come as no surprise: over 65% of the country’s deposits were already dollarized even before the economy underwent the official process. Furthermore, this figure does not recognize the volume of deposits that Ecuadorians had in offshore banks belonging to local institutions: that would lift the proportion of dollar deposits well over 80%. In essence, the government was the last entity in the country to dollarize, as the population was using the dollar as its measure of value long before it became official currency. It is important to recognize that the dollarization of the Ecuadorian economy took place long before the government decided to adopt the dollar as official currency. In other words, the citizens of Ecuador had already decided which currency they would use in their private lives to preserve their wealth.
This situation is also true of many other countries with weak currencies. In fact, devaluing currencies are the result of an unfair transfer of wealth whereby governments confiscate citizen’s private property through the hidden taxes of inflation and devaluation. With good reason, citizens react to this unfairness and protect themselves from it by adopting instead a currency that does not confiscate their wealth. Unofficial dollarization is a clear message to central banks that they are not doing their jobs properly, and its extent can be used as a measure of a government’s commitment to protecting private property.
Making dollarization official also has implications for the distribution of wealth. Under an inflationary system, there is a constant transfer of wealth from the poor to the rich. The poor do not keep dollars and therefore cannot reap any benefits from an ensuing devaluation. Those with dollars – the rich – receive a benefit from the devaluation as they can sell their dollars for more local currency each time. Essentially, a system that tends to devalue gives the rich elements of society a further advantage at the cost of the poor elements. Dollarization, by contrast, levels the playing field for everybody and sets the stage for economic stability: a necessary but not unilaterally sufficient condition for sustainable economic growth.
The decision to dollarize, however, is not without cost when many companies must start competing in a globalized economy. This is not easy in a country that has much protectionism and whose economy is classified as “mostly un-free” in the Heritage Foundation’s Economic Freedom Index. Nevertheless, the economic global integration process has to start somewhere: it might as well get going sooner rather than later.
More Security
Dollarization is in tune with the idea that eventually only a few currencies will prevail in the modern world. As during the ascendancy of gold as the standard measure of currency, dollarization should gradually erode the concept of foreign exchange risk. A world with less financial transaction risk should be a world with more capital mobility. By reducing the risk of devaluation, a country provides more security for investments, foreign and domestic. Of course, this is not the only factor foreign investors consider, but it is a good start.
The elimination of devaluation has other implications for entrepreneurs too, whether foreign or domestic. It becomes easier to plan into the future and make profit projections once your company’s profit or loss no longer depends on your capacity to navigate the extremely treacherous waters of a constantly changing currency value. Today, the enterprise realizes its true profits, now that the value of the currency is stable. No longer will firms be in the money simply because they better anticipated currency fluctuations. In other words, consumers matter more now, as they – rather than devaluation – are the major source of income.
Ill-Founded Comparisions
Concerns about the similarity of dollarization with the Argentine scheme are ill-founded. To begin with, dollarization is very different than the sui generis scheme applied in Argentina. Convertibilty had the makings of its own demise within its very own structure, whereas dollarization goes one step further in eliminating uncertainty in the monetary scheme. Many have said that fiscal imbalances are inconsistent with dollarization and have cited that as the key element in Argentina’s downfall. The truth is that fiscal imbalances are a problem no matter what monetary scheme is applied, and dollarization simply allows you to recognize the problems more quickly, and therefore – once recognized – the problems can be resolved. Concerns over persistent fiscal imbalances will always exist and a dollarized economy is no different in this respect. At least under dollarization, governments must attempt to balance the books as they have no easy ways to finance any imbalance.
One of Ecuador’s natural resources is oil. Recently a private concession was set up to finance and build a new trans-Andean pipeline to transport heavy crude from the Amazon-based oil fields(see “Ecuador’s Future Flows Through a Pipeline,” p.26). The cost of this project is estimated to be about $1 billion and once the project is finished, should double the capacity of oil production for Ecuador. There are various other related activities in the oil and energy industries that should attract a further $3 billion in investments in the next few years. The economic growth spurred by those new investments in the sector should give the country a badly needed jump-start. The new money should generate increased demand and consumption, which, coupled with a stable currency, give the entrepreneurs the necessary conditions for growth. Economic growth and a stable currency give Ecuador a fighting chance in the globalized economy. Our entrepreneurs now have two conditions they badly needed to turn the petroleum-driven growth into a sustainable pattern of wider growth: capital and stability.
Eight years ago, I wrote an article for LatinFinance commenting on the investment opportunities in Ecuador. Today, although many of the conditions that were present then are still present now, the panorama is clearly different. Dollarization has changed the country and its outlook beyond question. Blessed with natural resources, and a history rich with curious facts, Ecuador is now poised for years of economic expansion.
Francisco Zalles is senior Latin American consultant to Van Eck Global, a US- based mutual fund company, and is also an influential economist associated with think tanks in the region. He is based in Ecuador.