Ecuador's Mahuad Rolls the Dollarization Dice: David DeRosa
By David DeRosa
Ecuador's Mahuad Rolls the Dollarization Dice: David DeRosa
(David DeRosa is president of DeRosa Research and Trading
and manages an investment fund. He is also an adjunct finance
professor at Yale School of Management. His opinions don't
necessarily represent those of Bloomberg News.)
New Canaan, Connecticut, Jan. 12 (Bloomberg) -- Desperate
times call for desperate measures. You could hang that banner on
the office of the president of Ecuador, Jamil Mahuad Witt, who
made a snap decision this weekend to dollarize his country.
Ecuador and its currency are in a virtual freefall. Mahuad
is grasping for any way to stop the hemorrhage and wanted to
secure the value of the currency. His idea is to replace the
Ecuadorean sucre with the U.S. dollar at a rate of 25,000 sucres
to $1. As is the case with Panama, the original and, to date,
only country to dollarize, the sucre would remain in circulation
for a while and then disappear.
Not everyone cottoned to this idea. To be specific, the head
of the Ecuadorean central bank, Pablo Better, who only days
earlier had stated that neither a currency board nor
dollarization was under consideration, quit on the spot. Cabinet
resignations followed. Yet Mahuad is adamant and it looks like
he'll get his way. There were some initial protests but now it
looks like the body politic in Ecuador is backing dollarization.
Dollarization first became a big topic of discussion last
May when former Argentine President Carlos Menem proposed
converting Argentina from a currency board into a fully
dollarized economy. Menem was so enthusiastic about dollarization
that he proposed it for all of South America. The idea was pretty
much retired from discussion when he handed over the presidency
to his successor, Fernando de la Rua.
Divvy Up the Spoils?
Still the idea periodically finds supporters in unlikely
places. For example, U.S. Senator Connie Mack, a Republican from
Florida, has introduced a bill called the ``International
Monetary Stability Act of 1999.' The bill asserts the U.S.
should ``encourage official dollarization by offering to share
with countries that become officially dollarized a portion of the
extra seigniorage earning that the United States would earn.'
Seigniorage refers to the free interest that a central bank
implicitly collects from having people hold the nation's
currency. In effect, a central bank's ability to issue currency
is tantamount to its receiving an interest-free loan from the
general public. If Ecuadoreans hold dollars, the seigniorage goes
to the U.S. Federal Reserve.
Mack's bill makes interesting reading because it contains an
actual algebraic formula on how the seigniorage would be divvied
up between the U.S. and the country that chooses to dollarize.
This brings up a fine point. Mahuad may be leaving a nice
chunk of change on the bargaining table. He has in effect made a
unilateral decision to adopt the dollar as Ecuador's currency.
The decision was made under duress because his poor country is
going over the falls in a barrel. Apparently he didn't have time
to make a deal with the U.S. on the seigniorage issue. Maybe it's
not too late to negotiate.
Pay Uncle Sam
Still maybe the Fed should get all of the seigniorage.
Consider it a fee for providing a stable currency. And there is
risk to the U.S. from having an economically unstable emerging-
market country using its currency. If Ecuador implodes after it
has dollarized, you can bet your boots traders are going to sell
the dollar. Of course this would be more of an issue if one of
the larger Latin American countries, like Argentina or Brazil,
were to dollarize.
I have to admit that in some sense dollarization is like an
instrument of the Monroe Doctrine for international finance. One
hemisphere, consisting of North and South America, with one
currency, the Yankee greenback. And no euros allowed!
Maybe that's going to be the drill for the new century.
Forget political alliances and go for currency blocks. The euro
may have started a new craze.
Whatever pans out, you can safely assume the future of
dollarization in Latin America and the career of Jamil Mahuad
Witt now ride on what happens in dollarized Ecuador. If this
plan, which seems good in theory, fails in practice,
dollarization will be discredited. Except for Panama, and that
was a special case, this kind of thing hasn't been tried before.
But if it works, and if Ecuador shows economic improvement, then
hello to a dollar destiny.
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