These days Federal Reserve chairman Alan Greenspan makes policy not only for the United States but for a growing swath of Latin America as well. Ecuador, facing a crisis of hyperinflation, replaced the sucre with the dollar last year. Guatemala passed a law in December allowing free circulation of dollars alongside the national currency–something already allowed in Peru and Bolivia. Honduras, Nicaragua and Costa Rica are discussing switching to the dollar. The idea of “dollarization” has been mulled over even in Mexico, where nationalist fear of domination by the United States runs particularly hot.
For now, all eyes are on El Salvador’s grand experiment, which overnight converted bank accounts to dollars and reprogrammed automated-teller machines to dispense only dollars. Schools are teaching the 8.75-to-1 colon-to-dollar conversion tables so kids will learn how to think in dollars. With the slogan “Monetary integration: Good for you, good for the country,” the greenback is hyped by the neoliberal government of President Francisco Flores as the future of prosperity, a boon for the middle class, even the antidote to the devastating earthquakes that struck this month and last.
The idea of dollarization would have been unthinkable in Latin America even five or 10 years ago. But a decade after market liberalization swept the continent, hopes of economic revival have gone largely unrealized. Central banks have failed at their job–stabilizing the local currency–setting off massive inflation. Parties of the right see the dollar as a way of bringing order to the chaos by forcing even soft-money radicals to obey the hard-money discipline of America’s inflation fighter in chief. They are willing to dollarize even if it means swallowing their national pride and entrusting monetary policy to the U.S. Federal Reserve. “It is like castration,” says Sebastian Edwards, an economics professor at the University of California, Los Angeles, and the former chief Latin American economist at the World Bank. “You can teach abstinence to kids, or you can castrate them. Castration seems like a drastic last resort. Yet dollarization is being embraced with a religious fervor.”
Though not a cure-all, the dollar may be the right medicine in some countries. Economists see it as a gateway to lower interest rates, lower inflation, smoother trade flows and more credibility with investors–particularly in small countries already highly dependent on the United States. This may be the start of something even bigger. If El Salvador starts attracting banks and other investors, it will be tough for neighbors not to follow suit on dollarization. Pressure from U.S. banks could push the trend even further. “As U.S. banks and financial institutions become more involved in Latin America, their well-being will depend more on what happens in those countries,” says Roberto Chang, a Rutgers University economist who studied the issue for the U.S. Federal Reserve. “The hemisphere will move to a single currency, which naturally will be the dollar.”
Not without a fight. Arguing that they need control of monetary policy to provide soft money for spending on such things as health and education, leftist parties are fighting the dollar at every turn. In El Salvador, two parties of the left have filed lawsuits with the Supreme Court to keep the colon. Street protests planned in several towns were canceled by this month’s devastating earthquake, but passions still run high. “It is unconstitutional,” says Manuel Melgar, a congressman from the FMLN, the former guerrilla army. “It takes economic power away from the government.” In Guatemala last November, Congressman Otoniel Fernandez had just made a speech to Parliament attacking dollarization when he received a phone call. “The voice on the line told me to stop defending the poor and the dispossessed or else I would be at risk,” he recalls. “I denounced the call on the spot on the floor of the Congress.”
El Salvador had debated dollarization for several years. In some ways, it was an easy transition, because the dollar already dominates the country. Some 65 percent of exports from El Salvador go to the United States (compared with less than 25 percent from Brazil and Argentina). Last year the 1.5 million Salvadorans in the United States wired home $1.7 billion–representing 15 percent of GDP in a nation of just 6.5 million. The exchange rate has been fixed for most of the past decade. And the boom of the early 1990s has tapered off as world market prices for coffee and sugar fell. The ruling Arena Party saw dollarization as a way to secure its economic legacy should the left come back to power. Says Juan Jose Daboub, chief of staff to Flores: “We want to avoid the possibility that a future government, in a populist manner, will play with the savings of the people.”
So in late December El Salvador made a withdrawal from its $1.96 billion in reserves kept in U.S. banks. Of the $200 million the government has imported, $71 million has been put into circulation as the central bank collects colons in exchange for dollars. The government canceled contracts with companies in Canada, the United States, England and Germany that used to mint colons. Shops plan to post prices in both dollars and colons until July; by then the government expects dollars to account for half the $500 million in circulation. The plan is to eventually phase out the colon completely, but there is no target date. In the meantime, teachers are drilling their students on the multiples of 8.75.
The Jan. 13 earthquake, which killed 800 people and caused up to $1 billion in damage, could slow down the currency transition. The quakes last week, which killed at least 400 more, also compounded the economic damage. But the disasters are already giving greenback supporters a chance to show off the benefits of the currency. Last month the country’s four biggest banks announced loans as low as 8.9 percent for rebuilding homes and businesses. Interest rates for colons had been 17 to 25 percent before the president announced the decision to dollarize in November.
But for now the colon is still king in San Salvador. Some bus companies refuse to accept dollars, arguing that the government-set fare of 17 U.S. cents, rounded down more than a 10th of a cent, cheats them out of hundreds of dollars a day. At the sprawling central market, most shops have sold out of what has become the country’s most important gadget: the pocket calculator. Delmy Roque, 27, who sells beans and garlic, vows to refuse dollars until colons simply run out. Worried by the prospect of having to make change in nickels and dimes, she asks: “Why don’t the Americans put numbers on the coins?”
Ecuadorans had no choice but to adapt. In 1999 falling oil and banana prices and El Nino storms sent the economy into its biggest recession of the century. After the sucre plummeted, the debt-ridden government gradually replaced it with the dollar between January and September of last year. Ecuador now has monetary stability, but its old problems remain: lack of growth and high debt. The International Monetary Fund recommended fuel-price rises as an austerity measure, inspiring Indian-led protests that ended earlier this month after deadly clashes with riot police. And with a population still getting used to the dollar, Ecuador has become an easy target for expert counterfeiters from neighboring Colombia, which produces more than a third of the world’s fake dollars.
The truth is that adopting the dollar is still a rare and uncertain experiment. At least 10 countries use the greenback, but most are too small and obscure–from Kiribati to Andorra–to be instructive. The only relevant example is Panama, which has used the dollar since the United States orchestrated its independence in 1904. The dollar–combined with banking-secrecy laws, a free-trade port and the canal–has made Panama a service center for Latin America. Annual inflation averaged 2.4 percent for the past 45 years, and Panama has long been one of the few places in Latin America with long-term fixed-rate mortgages for home and car buyers. That’s the good news. The bad news is that Panama is a chronic debtor, and the Western Hemisphere’s biggest user of IMF relief programs in the past quarter century. As Desmond Lachman, an emerging-markets strategist at Salomon Smith Barney, points out, “The dollar might be conducive to better economic management, but it is no guarantee.”
It is also a potential trap. Consider the famous case of Argentina, which pegged the value of the peso to the dollar after the hyperinflation crisis of 1991. The peg lowered inflation. But when neighboring Brazil devalued its currency, the real, in 1999, Argentina could not do the same to protect its exports and remain competitive. Argentine wages fell, and unemployment hit double digits for the second time in a decade. Adopting the dollar is an even more drastic measure than the peg, because it cannot be abandoned at a moment’s notice.
The United States remains publicly neutral on the dollarization trend. During his presidential campaign, George W. Bush often mentioned his desire to create a free-trade zone of the Americas, but so far his administration, perhaps not eager to play the part of the meddling gringo, refuses to say whether that would include encouraging countries to adopt the dollar. Depending on what happens in El Salvador, the small Central American countries may not need much prodding to dollarize. This much is clear: they would be embarking on a strange journey with uncertain results.
