Tuesday, November 25, 2008

Poorly Explained Explanation Time--Ecuador Goes to the Dollar

No one has jobs or money anymore, but virtually everyone we know is an unmarried, childless, non-homeowner, so we will all be fine probably. If you don't fall into those categories, our sympathies. Even though we'll be ok, we all get worried and talk about the horrible economy and try to make sense of it using blogs and NPR.

What gets hard to understand is an event that happened relatively recently, but hasn't been on This American Life this American month. This situation came up the other night during a discussion of Ecuador, and how it switched to the dollar sometime a while ago. Why did that happen? What did it mean? Ira, come quick! Let's see if we can make any headway, despite an acute lack of understanding of international economics or Ecuadorian history and domestic & foreign policy.

Let's start at an arbitrary beginning. From the Sept 12th 2000 AP wire:

QUITO, Ecuador (AP) - The American greenback ruled supreme in this small Andean nation on Monday, the first day of business since it replaced the sucre as Ecuador's national currency.


Ecuador, wracked by political and economic disorder for years, on Saturday completed a six-month transition to making the U.S. dollar its currency. During the transition both dollars and sucres circulated as legal tender, at an official exchange rate of 25,000 sucres to the dollar.

Ecuador joins nine other countries or territories using the U.S. dollar as their official currency, according to the International Monetary Fund. They include Panama, Guam, the Marshall Islands, Micronesia, Palau, Puerto Rico, American Samoa, the British Virgin Islands, and the U.S. Virgin Islands.

Officials hope the switchover will end record inflation running at 104 percent a year, Latin America's highest. The step is designed to prevent the government from printing excessive money to meet its budgetary needs. Economists blame Ecuador's economic woes on decades of deficit spending.

Decades of deficit spending? That doesn't sound good. Investorwords defines deficit spending as:

The amount by which a government, company, or individual's spending exceeds its income over a particular period of time. also called deficit or called budget deficit. opposite of budget surplus.

All right, sir. Let's back up. The Ecuadorian government was printing too much money for too long, and spending more than it was bringing in, ie deficit spending. All that extra printed money caused inflation, so a bag full of sucres was virtually worthless. Then President Mahuad announced his intention to move to the dollar, and was subsequently removed from power. His Vice President filled his seat. According to Wiki:

The [Gustavo] Noboa government confirmed its commitment to dollarize as the centerpiece of its economic recovery strategy, successfully completing the transition from sucres to dollars in 2001. Following the completion of a one-year stand-by program with the International Monetary Fund(IMF) in December 2001, Ecuador successfully negotiated a new $205 million stand-by agreement with the IMF in March 2003.

What, other than inflation, caused this?

Deteriorating economic performance in 1997-98 culminated in a severe economic and financial crisis in 1999. The crisis was precipitated by a number of external shocks, including the El NiƱo weather phenomenon in 1997, a sharp drop in global oil prices in 1997-98, and international emerging market instability in 1997-98. These factors highlighted the Government of Ecuador's unsustainable economic policy mix of large fiscal deficits and expansionary money policy and resulted in an 7.3% contraction of GDP, annual year-on-year inflation of 52.2%, and a 65% devaluation of the national currency in 1999.

So a mix of bad fiscal policy, weak international markets, and El Nino weakened the sucre to the point where it was worthless. Make sense? Explaining why this was ultimately not so great for the country, and why the IMF and World Bank are rotten institutions will have to wait for another day.

Jokes about poops in bowls to return tomorrow.

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