Dollarisation in Ecuador

Over at the free banking blog, Larry White has a very interesting post on dollarization in Ecuador. He outlines the history of the dollar in Ecuador and rehearses some of the key arguments in favour of free banking, and against its critics.

The dollarization of Ecuador was not chosen by policy-makers. It was chosen by the people. It grew from free choices people made between dollars and sucres. The people preferred a relatively sound money to a clearly unsound money. By their actions to dollarize themselves, they dislodged the rapidly depreciating sucre and spontaneously established a de facto US dollar standard.

Finally, in January 2000, Ecuador’s government stopped fighting their choice. Until that point the state tried to use legal penalties or subsidies to slow currency switching. Today the state threatens an attempt to reverse the people’s choice through legal compulsion.

He points out that the dollar was consistent with rapid economic growth and general success: between 2000 and 2013 the Ecuadorean economy grew a cumulative 75%, or an average of 4.4% annually, compared to just 36% in the previous 13 years (equivalent to 2.4% annually). And dollarisation has not just been good for output and living standards, but also the stability of banks:

Dollarization has also brought improvement to Ecuador’s banking system, according to two analysts at the Federal Reserve Bank of Atlanta. Mynam Quispe-Agnoli and Elena Whisler, in a 2006 article, noted correctly that dollarization, by ruling out an official lender of last resort able to create dollar bank reserves with the push of a button, eliminates an important source of moral hazard.

In this way dollarization has the potential to reduce risky bank behavior, and thus so “make banks runs less likely because consumers and businesses may have greater confidence in the domestic banking system.” Lacking the expectation that “the monetary authority would come to the rescue of troubled banks” whether solvent or insolvent, banks in a dollarized system “have to manage their own solvency and liquidity risks better, taking the respective precautionary measures.”

He ends by giving strong warning that a return to state compulsion in the use of currency will worsen the country's prospects. The state seems, White suggests, to be trying to bring back state currency control on the sly, through unifying all mobile payments under one system, something he argues is completely unnecessary.

In sum, there is no plausibly efficient or honorable reason for the Ecuadoran government to go into the business of providing an exclusive medium for mobile payments. Consequently it is hard to make any sense of the project other than as fiscal maneuver that paves the way toward official de-dollarization. I gather that President Correa does not like the way that dollarization limits his government’s power to manage the economy. He has compared the limitation to “boxing with one arm.” But as I have already emphasized, retiring the government from boxing against the economy by means of money-printing is precisely dollarization’s great virtue.