Day of the Dollar

Ecuador adopts U.S. currency to stabilize economy,

but the move is causing a cultural identity crisis

Jim Wyss / SF Chronicle 25jan01

Quito, Ecuador -- Shortly after Ecuador adopted the U.S. dollar as its official currency last year, fruit vendor Hilario Chirao stared at a handful of nickels, dimes and pennies that a customer had just given him.

"The coins didn't have any numbers on them and I can't read English," recalled the 34-year-old street fruit vendor. "And I thought that there is no way that the little coin (a dime) could be worth more than the bigger ones."

Although Chirao is still uncomfortable with the new currency, he has learned to live with it.

Increasingly, governments throughout the region are hoping that their citizens will also learn to live with the U.S. greenback and America's distinctive coins as they turn to the dollar to calm nervous bankers, spur foreign investment and trade, and tame rising inflation.

On Jan. 1, the dollar joined El Salvador's colon as the official currency. In May, Guatemalans will be able to open dollar bank accounts and sign contracts in dollars. If these experiments work, several other Latin American nations are poised to take the plunge, analysts say. They reportedly include Costa Rica, Jamaica, Argentina and Paraguay.

"El Salvador will be a big test for other Caribbean and Central American countries," said Michael Henry, an analyst on Latin America for the Amsterdam- based global banking group ABN AMRO. "If it works there, I think we could see others follow."

In theory, dollarization helps cure several nagging economic problems. It is a guarantee that bank savings won't evaporate under a currency devaluation and that investors won't be put off by fluctuating exchange rates. Such economic stability can bring down interest and inflation rates, which in turn boosts domestic spending.

Ecuador made its move last September while facing its worst economic crisis in 70 years, which featured hyperinflation and crumbling financial markets. President Jamil Mahuad announced he would discard the nation's century-old sucre after the currency had soared from 7,000 to 25,000 to a dollar in the previous 18 months.

"In our case, dollarization was a life raft," said Quito economist Pablo Lucio Paredes. "We didn't have many options."

The desperate move didn't save Mahuad, however; he was deposed three weeks later in a coup led by an unlikely group of army officers and indigenous leaders. But the currency switch did bring an inkling of economic stability to this small Andean country of 13 million inhabitants.

Although annual inflation hit 91 percent at the end of 2000 -- the region's highest rate -- most analysts agree that it would have been far worse without dollarization. But these same analysts also agree that Ecuador still needs to make sweeping economic and political reforms before dollarization's benefits can take root.

"Whether or not dollarization has worked is an open question," Paredes said.

Dollarization is not new. Panama has been using U.S. currency since 1903 -- although it is called the Balboa -- and Argentina has pegged its peso one-to- one with the dollar since 1991. In Cuba, the dollar is known as the fula and is a coveted means of exchange.

But it is El Salvador's formal, well-planned leap into the arena that has caught regional attention.

El Salvador's colon has been trading at a steady 8.75 to the dollar for the past seven years, and annual inflation has averaged an enviable 2 percent over the past three years. Moreover, El Salvadorans living in the United States send back an estimated $1.5 billion annually to their families.

Nevertheless, government officials decided that dollarization was the best way to integrate with a globalized economy. "We are entering this process from a position of strength," explained Central Bank President Rafael Barraza. "We didn't have to dollarize, we chose to."

But despite the benefits of the cure, the medicine has been difficult to swallow for many Latin Americans.

"The withdrawal symptoms have been terrible," said Ecuadoran President Gustavo Noboa in reference to nostalgia for the old currency. "When (Ecuadorans) see Grant or Franklin on a bill, it doesn't mean anything to them.

It has been a tremendous cultural blow."

When the sucre was completely pulled out of circulation, posters of the 19th century revolutionary hero Antonio Jose de Sucre -- whose image adorned most bills -- were plastered in many Quito bars with a bullet through his head under the epitaph: "Hasta la vista, baby."

That image strikes a chord with Salvadorans who argue that they are sacrificing economic sovereignty.

"From now on, our monetary policy will be directed by (the U.S.) Federal Reserve, and that violates our Magna Carta," said Balmore Barahona, spokesman for El Salvador's largest opposition party, the leftist Farabuno Marti National Liberation (FMLN) Front.

A key player in the country's bloody civil war during the 1980s, the FMLN now fights for change from its 31 congressional seats. The party, along with a coalition of social groups, recently filed a lawsuit against dollarization, charging that the government's failure to consult opposition parties was unconstitutional. The legal case is unlikely to be resolved for at least a year.

Without the ability to print its own bills, dollarized countries are virtual hostages to U.S. monetary policy. They also lose the ability to use homegrown exchange rates and monetary policies to dampen domestic economic crises.

When the Federal Reserve lowered interest rates early this month, the effect was felt immediately throughout Latin America and particularly in dollarized economies. Argentina's stock market soared as if the decision had come from the Central Bank in Buenos Aires.

In Washington, the Treasury and Fed are well aware of their growing influence in the region and the potential political pitfalls.

"In difficult times, or when U.S. monetary policy is considered inappropriate or inconvenient for the dollarized country, there would be the risk that U.S. policies would foster resentment and encourage policy makers to deflect blame for their countries' problems on the United States," Edwin Truman, a former assistant Treasury secretary for international affairs, told Congress last year.

As a result, the Treasury does not officially encourage dollarization, saying its success or failure depends on the countries that choose to go that route.

Back at his fruit stand, Chirao's complaints are now limited to the greenback's aesthetic look.

"Things do seem to be better with the dollar," he said as he compared a dollar bill to a colorful sucre note. "But these new bills really are ugly. Why do they have to make them all green?"