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Dollarization in Latin America
A study of
Argentina - Ecuador
Jeff Cotter, Delphine Pape, James Phillips, Victor Pinto,
Gary Sidell, Betsy Townsend
Dollarization
• A country uses the dollar/another currency
alongside or instead of the domestic currency
• Uses include:
– Payment for wages, Consumer purchases, Tax
Payments, Government Payments
• Unofficial vs. Official dollarization
How Unofficial Dollarization
Works
• Informal/Unofficial
• Formal/Unofficial Dollarization
– Currency Board established
• Authority to issue domestic currency at fixed exchange rate in
concordance with the international reserve.
• Maintains full, unlimited convertibility.
– Orthodox/Unorthodox Currency Boards
How Official Dollarization Works
• Dollarized country relinquishes its monetary policy
and adopts the policy of the issuing country.
• Inflation and interest rates tend to be the same
between the two countries.
• Money Supply is determined by the Balance of
Payments.
• Financial integration occurs as foreign and
domestic financial institutions compete.
Why Consider Dollarization?
• Create Fiscal and Monetary discipline
• Lower and stabilize inflation
• Increase reliability of financial markets
•
interest rates &
access to long term debt
• Create a more stable business environment
Costs/Benefits of Dollarization
Costs
• Loss of flexibility in
monetary policy
• What is good for US may
not be for others
• Lost revenues of
seigniorage
• No central bank as lender
of last resort
Benefits
• Fosters budgetary
discipline/credibility
• Lower international
transaction costs
• Lower inflation today
and lower risk of future
inflation
• Stable interest rates
Cost of Dollarization Seignorage
Loss of Seignorage Revenue as a % of GDP
8.00%
6.00%
4.00%
2.00%
1991-1997
ua
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Av
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ag
e
Pe
ru
Ec
Ar
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nt
ina
M
ex
ico
Br
az
il
Bo
liv
El
ia
Sa
lv a
do
r
0.00%
1991-1997
Argentina: History
• Pre-1991: Hyperinflation (up to 5000%)
– unofficial dollarization
• 1991: Convertibility Law passes
• 1994: Foreign financial institutions compete
on equal basis with Argentine institutions
• February 1999: Propose official dollarization
Convertibility Law =
Unofficial Dollarization
• Central Bank must hold reserves = 100% of
monetary base (currently $13.9 bil.)
• 1:1 exchange rate - 10,000 australes per $1,
new Peso equal to 10,000 australes
• Law prevents central bank from printing
money (limits powers as lender of last
resort)
Convertibility Plan
Performance
• Relative economic stability since 1991
• Interest rate spikes
– during Mexico’s currency crisis in 1994-5
– during Asian and Brazil currency crises since 1997
• Speculative pressure against Argentine peso
until government threatened to dollarize
Argentine Inflation after
Economic Restructuring
5000%
4000%
3000%
2000%
1000%
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
0%
Dollarization Goals
• Eliminate speculation about the Peso devaluation.
• Lower/eliminate spread between U.S. and
Argentine interest rates.
• Restore confidence in the Argentine monetary
system.
Dollarization Concerns:
Applicability to Argentina
• The peso, a symbol of
Argentina / loss of
independence
• Lose revenue derived
from seignorage
• Lose ability to cope
with external shocks
• Argentines already use $
under Convertibility Law.
• Revenue is minimal
because they do not
have freedom to print
• Not proven (evidence
shows dollarized
countries do better).
Argentina Today
• Convertibility Law still in effect.
• No immediate plans to officially dollarize
under new President Fernando de la Rua.
• Debate/discussion continues - Argentine and
American officials met last month in
Washington to discuss dollarization.
Ecuador: All is not Well
• Worst economic crisis in five decades.
– Economic and Natural environment
• Social consensus for economic reform needed
– President proposes ending the severe recession with
implementing dollarization, in 180 days.
– President overthrown, new president implements
• International Reception:
– Well internationally, along with a belief of
“Dollarization out of Desperation” -IMF head Stanley Fischer
Dollarization: The Plan
• Swap Rate
– 25000:1
• Central Bank 180 days to exchange currency
– $936M in reserves
• Financial Institutions
– Transact in $US
• Accounting (public/private entities &
individual)
– Expressed in $US
Dollarization: The Plan
• Debt
– Individual & company debt >$50K US
restructured to settle in 3-7 years
• No capital controls on foreign currency
• Interest rates with a maturity of 1/10-11 2001
– 16.82% on loans
– 9.35% for deposits
• Finance Minister may not present a budget
with a deficit exceeding 2.5% of GDP
Goals
• Increased confidence spurs foreign
investment and trade
– remove currency risk
– curbs hyperinflation
• Privatization of SOE’s
– pipeline investment
Dollarization Has Occurred:
Now What?
• $900M in loans--IMF
• Stimulate new capital inflows
• Gain full domestic support through additional
legislation.
– Guarantee of part time wage of $.50 per hour
• May receive 85% of seignorage benefits of
dollarization from US.
Dollarization
• Brings discipline & stability to financial markets.
• Not a formula.
• Difficult and expensive to implement depending
on circumstances.
• Often has proven to achieve objectives.
– GDP growth , lower inflation, lower interest rates
Effects on US & other countires
• US has broader responsibility to consider
effects of fiscal policies on dollarized nations.
• Caution: IMF funding Programs should not be
regarded as surrogate central bank
opportunities.
Sources
• Central Bank of Argentina (www.bcra.gov.ar)
• Hanke, Steve H. and Schuler, Kurt, A Dollarization Blueprint for
Argentina, “Friedberg’s Commodity and Currency Comments Experts’
Report”, February 1, 1999.
• Calvo, Guillermo, Argentina’s Dollarization Project: A Primer,
February 18, 1999.
• Argentina Mulls Dollarization, (www.oir.com)Optima Investment
Research, 1999
• “Dollars enticing South of the Boarder, US Passive to Trend Despite
Benefits” -Washington Times, February 17, 2000
• Calvo, Guillermo A., “Testimony on Full Dollarization” Presentation
before Joint Hearing of the Subcommittees on Economic Policy and
International Trade & Finance. April 22, 1999.
• Cardosa and Franko texts
More Sources
• Reuters news service, 2/29/00, 3/1/00 and 3/3/00
• Casey, Michael Dow Jones Newswires “Ecuador’s Dollarization Plan
Fuels Talk, If Little Else” 3/3/00.
• Casey, Michael Dow Jones Newswires “A Wary Wall Street Welcomes
Ecuador Dollarization Bill” 3/1/00
• http://sica.gov.ec/ingles/docs/basics_of_dollarization.htm
• http://www.odci.gov/cia/publications/factbook/ec.html
• ABC-CLIO, Inc., Kaleidoscope
Sources
• Dollarization, July 1999, Joint Economic Committee Staff Report
Office of the Chairman, Connie Mack Prepared by Kurt Schuler,
Senior Economist to the Chairman*
• U.S. Senate Banking Committee “Citizens Guide to Dollarization”
1999
• Should there be five currencies or one dundred and five? Ricardo
Hausmann
• U.S. Senate Joint Economic Committee Report “Basics of
Dollarization,” January, 2000 (www.senate.gov/~jec/basics.htm)
• Three cheers for Dollarization. Euromoney, London 1999. Steve
Hanke
• http://users.erols.com/kurrency/ intro.htm *
• http://users.erols.com/kurrency/, OFFICIAL OR "FULL"
DOLLARIZATION: CURRENT EXPERIENCES AND ISSUES by
Zeljko Bogetic, International Monetary Fund, June 9, 1999.*
*copy included in Word document “doll2”