Ecuador and dollars

Factual Questions
1

Pardon my economics ignorance in advance. :slight_smile:

I was reading about Ecuador now using the U.S. dollar for its currency. I’ve read in the past how other countries are doing or have considered doing the same.

My question(s):

Do they have to get U.S. permission, or clearance to do this? (probably not)

Does the U.S. print extra money to cover the new demand for dollars?

Does this affect U.S. consumers (or businesses) in any way, or is the Ecuadorean economy so small that it doesn’t matter?

Thanks,
-Andy

2

I’ll be happy to irresponsibly post without citation and with an overabundance of anecdotes.

*Russia, after the collapse of the Soviet Union, has relied heavily on the American Dollar as a medium of exchange. I’ve read that Lebanon and now Liberia rely on the same for large purchases.

*No doubt a significant amount of “American” currency in circulation throughout the world is in fact produced in Iran, who purchased nearly identical minting machinery, paper, and ink from the same manufacturers [Did anyone know that our paper money presses come from Switzerland? That’s an outrage!] in the 1980’s. They use it to pay terrorists, among other things. It is supposedly detectable as counterfeit here in the States.

  • Many countries, notably the Bahamas, encourage the use of American currency in their casinos. Winnings are usually paid in Bahamian money–part of the vig, I guess.

  • Some countries, and I won’t name names, use coinage that closely resembles American coins. I can tell you that Washington, DC does not like beavers, coin or animal.

  • Other countries have thriving black markets which rely on American currency as a baseline. Many, if not most, countries keep an artificially low official currency exchange in order to make a profit off of American tourists and businesspeople, and others using that currency. This was driven home to me personally in Puerto Vallarta, Mexico, where the official exchange rate diverged from the black market exchange rate by over forty percent in the mid-80’s. I did not make the same mistake in Caracas. In a similar vein, a few American dollars waved in front of a lot of Carribean drug dealers will buy a disproportionate amount of marijuana.

The funny thing is, the U.S. dollar floats on the same slush that the rest of the world’s currency does. I leave it to an economist to explain why the dollar remains so strong.

3

So, um, in answer to your questions, I don’t know.

4

I doubt they would have to get permission to do it, there are no longer significant capital or currency controls and the US government stands to gain quite a bit from them doing it.

Yes, more money would printed.

The issuer of currency essentially is able to swap bits of paper (or entries in a balance sheet) which cost almost nothing to produce for real assets. Governments (at least at the moment and I don’t see them giving it up) have a monopoly on the issuing of money. The revenue they get is called seigiorage.

When a country “dollarizes”, the seigiorage
its government used to get goes to the US government.

So as well as the symbolic blow of abolishing your currency, there is a substantial revenue cost to the government and society in general.

I know you didn’t ask, but why would you do this?

Many Sth American countries have had high (>50%) inflation for very long periods. Where as the revenue from printing money in the US is about 3% of government revenue, in countries with chronic inflation problems seigniorage can be the majority of government revenue. For various reasons, they are unable to finance their spending except by printing money.

Various things have been tried, but to cut a long story short, they mostly failed. IMHO this simply reflects that a system that hopeless has little chance of reforming itself. Using the dollar is tying the government’s hands irreversibly: the Ecuador government cannot print US currency, no matter how what the temptation.

5

I know it’s a cool word to use, but it’s spelled seigniorage.

However, I always thought it just referred to the value of a coin over the value of the bullion in the coin.

6

OK, this brings on the next round of questions:

Will the U.S. government (or the Federal Reserve, I assume) ship dollars straight to Ecuador? Or will Ecuador have to go through a bank and make a withdrawl (making sure to keep at least $50 in savings)?

I know there isn’t enough money for everyone in the U.S. to withdraw everything at once. What if everyone in Ecuador withdrew all their dollars? Is their economy big enough for it to matter?

I guess this is related to the above-- will this represent an appreciable increase in the money supply that will be noticed?

7

The current Secretary of the Treasury, Larry Summers, has expressed his desire that no more countries dollarize their economies. Fortunately, there’s not much he or anyone else in the U.S. government can do to stop it.

Work is the curse of the drinking classes. (Oscar Wilde)

8

If I recall correctly, Argentina was also planning on “dollarizing” their economy a year or so ago. The official position of the United States government is that they don’t like other countries basing their economies on American currency but will not take any active steps against the practice.

As others posted, many countries already have a de facto dollar economy. I believe a majority of American currency (not money) is held in foreign countires. And Treasury department estimates are that as much as a third of the foreign-held dollars are counterfeit.

9

shame overload

Seigniorage is a term that has recently come back into fashion in economics, and its meaning has shifted a bit, now referring to the revenue that government gets from printing money. This allows it to be used for the “inflation tax” which is when the government government prints lots of money and people pay for it by virtue of the holding costs of money rising.

It is still pretty close to your definition though: face value of a dollar is a dollar, resource value of what makes a dollar (remembering that paper money is only part of the money supply) pretty much zero.

picmr

10

Argentina has been (essentially) dollarized since 1991. The official currency is the peso, but every peso in circulation is backed by a U.S. dollar held in the reserves of Argentina’s central bank. What happened about a year ago was that President Menem proposed finally doing away with the peso.

11

Hey! We have a treaty for that! (Which you are now breaking by minting a Sackie that does not look like a loonie. But whatever.)

12

Does this mean that we’ll be minting an Ecuador quarter in 2009? :smiley: :smiley:

You must unlearn what you have learned. – Yoda

13

There are two ways to “dollarize” the economy.

(1) Black Market
This approach is what’s done in Russia, where the local currency is so soft (read: worthless) that transactions actually happen in U.S. dollars. The U.S. government doesn’t “ship” dollars over there, the free market system brings them. This was actually true during the Communist regime, as well; the ruble was worthless outside the country, and travellers coming in would smuggle in dollars (illegally) for use in the black-market (underground) economy.

This approach actually uses dollars, real live U.S. currency trades hands.

I was in Brazil during the zillion-percent a year inflation. I went into a shop to buy a present for my wife, found what I liked. The shopkeeper said to me, “The cost is Thus, but I’ll give you a 10% discount if you pay in cash rather than in credit card.” (This was because the credit card time delay in 1000% inflation was substantial loss to the store.) The she went on, “And I’ll give you another 10% discount if you pay in dollars.”

That’s the black-market dollar at work. There is an actual currency, but it’s pretty much useless, and so people accept real, honest-to-god dollars.

OK?

(2) Formal Government Action
The second way that a country pegs itself to the dollar is the example of Argentina or Hong Kong. They have a local currency (Argentine pesos, Hong Kong Dollars, etc) but the value of currency is tied to the value of the U.S. dollar. The Argentine peso has been worth about USD 1.00 since the peso was brought into existence. The Hong Kong dollar is fixed at about HKD 7.75 to USD 1.00 for at least fifteen years that I can remember.

Normally, currencies vary in price against each other, depending on a variety of factors (including governments setting the values arbitrarily.) When a country chooses to link its currency to the dollar, that currency doesn’t float, doesn’t vary, remains (reasonably) fixed in value against the dollar.

When a country fixes its currency against the dollar, the local currency is still used; it’s not as if normal people buy things for U.S. dollars. It’s just that the exchange value of the local currency against the dollar is fixed.

Most of continental Europe has similarly fixed their currencies against the Euro, for example.

I presume this is what Ecuador is planning to do, to fix their new currency (currently the sucre, at about 20,000 to the dollar as of January 1) to the U.S. dollar.

Hope that helps.

14

What’s happenning here is a little more than pegging. A peg is where the local currency is fixed to a particular currency. In recent years many Latin American countries have used a “crawling peg” or tablita as a substitute for monetary and fiscal control. Under floating exchange rates, one currency would depreciate against the other at a rate equal to the difference in inflation rates between the two countries. The crawling peg is designed to depreciate, but slower than the inflation differential. This is supposed to provide a nominal anchor which helps the government commit to slowing inflation.

It hasn’t worked though, since these schemes sooner or later collapse because everyone knows the government will buckle when the pressure gets too much. This expectation becomes self fulfilling and there is capital flight.

This is the problem with fixed exchange rate these days: unless the capital markets believe you will stick to the rate no matter what the policy is not credible, and trying to keep the exchange rate other than where it would be if it were floated cannot last.

If you want to fix the exchange rate, then, you really have to fix it. Two ways: monetary union (like most of the EU) or abolish your currency entirely.

picmr

15

I’ve lived in Moscow for about 18 months over the last few years, and the economy is largely dollarized, with the price of anything big (like apartments) quoted in dollars. Things are a bit different in retail stores, where there are some legal problems with actually quoting prices in what is not the legal tender of the country. Lots of places simply change their prices often. I’ve been in other places, especially restaurants, clubs, and bars, where prices are quoted in dollars or “exchange units” which are then multiplied by the day’s exchange rate.

In terms of impact on the American economy, I’d look at it this way: in addition to the demand for American dollars as a means of purchasing goods and services from the American economy, there’s an additional demand for dollars as protection against the hyperinflation in your local currency. Result: the price of dollars is higher than it would be otherwise, thanks to that extra demand. When the dollar is overvalued, Americans find that imported goods are cheaper, but American exports are more expensive for purchasers abroad.

What that leads to–an increase in the trade deficit–also jives with a similar back-of-the-envelope look at the same phenomenon. For a Russian to get US dollars, he or she has to exchange perfectly good oil or minerals for pieces of paper with US presidents on them that will often then be stuffed in a mattress: a US import but without necessarily a US export.