Another country which has successfully Dollarised – Ecuador..

Yesterday Prof Hanke wrote about Panama dollarising, today he writes about Ecuador doing the same.

He starts with continued woes of Venezuela, and then gets to Ecuador:

Facing this inflationary theft, Venezuelan’s have voted with their wallets. Indeed, they have unofficially begun to dollarize the economy. But, the only way to establish the rule of law in the monetary sphere is to officially dollarize the economy by officially dumping the hapless bolivar and replacing it with the U.S. dollar.

Ecuador, where I served as the chief advisor to the Minister of Finance, when that country dollarized, offers some lessons that merit Caracas’ attention.

Ecuador represented a prime example of a country that was incapable of imposing the rule of law and safeguarding the value of its currency, the sucre. The Banco Central del Ecuador was established in 1927, with a sucre-U.S. dollar exchange rate of 5. Until the 1980s, the central bank periodically devalued the sucre against the dollar, violating the rule of law. In 1982, the central bank began to exercise its devaluation option with abandon. From 1982 until 2000, the sucre was devalued against the dollar each year. The sucre traded at 6,825 per dollar at the end of 1998, and by the end of 1999 the sucre-dollar rate was 20,243. During the first week of January 2000, the sucre rate soared to 28,000 per dollar.

In the case of Ecuador, the inability of the government to abide by the rule of law was, in part, a consequence of traditions and moral beliefs. Ecuadorian politics have traditionally been dominated by elites (interest groups) that are uninhibited in their predatory and parochial demands on the State. With the lack of virtually any moral inhibitions, special interest legislation was the order of the day. For example, during the rout of the sucre in 1999, laws were passed that allowed bankers to make loans to themselves. In addition, state guarantees for bank deposits were introduced. These proved to be a deadly cocktail, one that allowed for massive looting of the banking system’s deposit base. This, as well as the collapsing sucre, enraged most Ecuadorians.

With the rule of law (and the sucre) in shambles, President Mahuad announced on January 9, 2000 that Ecuador would abandon the sucre and officially dollarize the economy. The positive confidence shock was immediate. On January 11—even before a dollarization law had been enacted—the central bank lowered the rediscount rate from 200% a year to 20%. But, this newfound ray of hope was threatening to some, and during a 24-hour period (January 21–22), a coup d’état ensued. While the Mahuad government was toppled, the coup was a bungled affair and the former Vice President Gustavo Noboa assumed the Presidency. He honored Mahuad’s dollarization pledge. On February 29, the Congress passed the so-called Ley Trolebus, which contained dollarization provisions. It became law on March 13, and after a transition period in which the dollar replaced the sucre, Ecuador became the world’s most populous dollarized country on September 13.

With much the same enthusiasm as Ecuador’s coup plotters and the rigidity of a dogmatic cleric, the critics of dollarization condemned it as something akin to voodoo economics. Well, the critics have been predictably proven wrong.

The misery index is an objective measure of just how well dollarization has worked. The index is equal to the sum of the inflation rate (end of year), bank’s lending interest rates and unemployment rate, minus the actual percentage change in GDP per capita. Simply put, a high index means higher misery.

In Ecuador, prior to the implementation of dollarization in 2000, the country sustained a misery index of over 120. The public suffered greatly from inflation, but after dollarization was implemented, high inflation was stifled and misery drastically fell. The accompanying chart shows the direct link between dollarization and the immediate and sustained decrease in misery. From 2003 through 2014, the misery index in Ecuador has been remarkably constant at around 20 — one of the lowest in Latin America.

Interesting cases on monetary systems around the world..

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