The Dollarziation of Argentina and Ecuador (2003)

ABSTRACT Many countries are repeatedly trying to find their way out of economic or problems. Several of these countries have turned to the United States' dollar as a means of doing so. The U.S. dollar is a medium of exchange used throughout the world that has proven to be a strong and stable currency. This paper focuses on the implementation of dollarization for the countries of Ecuador and Argentina. It starts with defining dollarization, and reviewing the main types of dollarization. It then gives an overview of each country prior to its implementing dollarization, and next analyzes each country as a result of dollarizing. Finally, it looks at the economic prospects for the countries. INTRODUCTION Over the last few centuries, many countries have experiences economic disasters. Economists and governments both have debated for years over the different exchange rate regimes and how they can help an emerging or ailing economy prosper. They have theorized about a variety of monetary policies to help control inflation and initiate growth in their economies. Two countries that have recently undergone changes to turn their ailing economies around are Ecuador and Argentina. Argentina and Ecuador have had tremendous struggles over the last few years, and had no choice but to drastically change the way their economies were managed. Both countries have resorted to a type of dollarization to try to improve the economic conditions. Dollarization, briefly summarized, is a process by which a country abandons its own and adopts the of a more stable country, commonly the United States' dollar. There are two main types of dollarization to consider: full dollarization and unofficial dollarization (Caplen, 1999). The term full dollarization means the total elimination of a country's currency, and its complete replacement with some form of a stronger currency. Full dollarization occurs when a government makes the official decision to use a foreign for all transactions including government and private debt, and both public and private bank accounts are converted to dollars. The country's monetary base is converted into a dollar-denominated currency, or U.S. Federal Reserve notes. In the process of full dollarization there is a lengthy time span of conversion into the new currency. There is usually a deadline established where all holders of the domestic have to convert all of their domestic into the new at a predetermined rate of exchange. After the designated deadline, the previous domestic becomes worthless. The U.S. dollar would then be their sole legal tender (Caplen, 1999). The more popular type of dollarization is unofficial dollarization. It is also referred to as currency substitution. Unofficial dollarization may occur when the value of the local becomes too volatile. Holders of the domestic look for a more stable currency, and begin to use it for purchases, personal savings, and loans. When using unofficial dollarization, both currencies exist throughout the economy. People do their transactions in either currency, and most businesses throughout the economy will accept either (Maroney, 2002). Countries have been using dollarization to stimulate their economy throughout the last century, but only recently has it become such a growing trend. Many citizens of countries that are plagued with high inflation or the devaluation of their start to look for a more stable to use. This process of finding and using a more stable is the beginning of unofficial dollarization. Once they start using this stronger, more stable they lose faith in their domestic which in turn devalues the domestic even more. This devaluation along with the new surplus of a strong stable are two strong factors which lead a country into the implementation of full dollarization (Maroney, 2002). …