Ecuador Marks Anniversary of U.S. Dollar

QUITO, Ecuador - Jorge Subia is nostalgic when he talks about this Andean nation's former currency, the sucre, and bridles with patriotic resentment when he recalls how it was replaced as the official legal tender by the U.S. dollar.

"It's a national question of honor. The sucre was ours and now we have the dollar from the United States," said Subia, a truck driver. "The sucre was part of Ecuador, like the nation's flag or the national anthem."

This week marks five years since former President Jamil Mahuad's Jan. 9, 2000, decision to phase out the sucre in favor of the greenback in what many considered a last-ditch rescue of the economy.

The step was designed to prevent the government from excessively printing money to meet its budgetary needs after decades of deficit spending. Most economists credit the changeover with halting the highest inflation in Latin America at 91 percent.

The switch — which spawned the creation of a new Spanish noun, "dolarizacion," or "dollarization" — has exceeded expectations.

Ecuador closed out 2004 with 1.95 percent annual inflation. A year ago, President Lucio Gutierrez predicted an inflation rate of 3 percent to 4 percent.

One wonders about the effect on the USA. The Dollar Supply is controlled by the Fed, which is supposedly adjusting it by controlling overnight lending rates and reserve rates among member banks. Now that Banks in Eucador are using dollars are they controlled by the Fed? I don't think so. Can't they create as much money as THEY want, not as much as Alan and his band of gnomes think they should have. They (Ecaudorian bankers) have a record of too much liquidity. What prevents them from causing dollar inflation. Dollars created in Ecaudor are not immediately available and transferable to the US market, but neither are they completely isolated.

Perhaps they are so small this is not an issue. What happens when Mexico, a much larger economy with many more ties into the USA goes this route?

I do not see this as a good trend for American citizens. It is yet another internationalist assault of the very idea of national soverignity. At least in Europe there was a semi-democratic process when they decided to move the continent to a single currency.

Here in the Americas it is being done "out of sight". I remember the stories (no doubt true) about 747s full of dollars being flown down five years ago. Did Congress authorize that?

Wake up sheeple! Your losing the Republic!!

Um... how could the Ecuadorian government print dollar bills?

Ecuadoran banks will create dollars the same way American banks create them. They lend out many times more than they actually take in on deposit. The new money just gets recorded in ledgers, spent via checks mostly, and netted against other banks through a clearing process. The Ecuadoran banks can't print actual US banknotes, but they can borrow those when they have a shortage just like US banks do. Most money is not in the form of currency.

Um... how could the Ecuadorian government print dollar bills?

Thanks for asking. They cannot print money like ours. But please understand that money is not created by printing. Only a small faction of all the available money is in the form of cash. Much more is held as electronic deposits. (That's why you can have bank runs. Banks have only about 3% of the total deposits as cash. There is not a dollar bill for every dollar in use .. not even near).

All money is created as debt in our system. Money is created when Money Center Banks make loans. These loans are then moved to the assetts column of their balance sheet and there is now more money in circulation.

Example: You want to buy a house. You go to the bank, they give you a loan. You now have instantly $300,000. The bank has an assett (a $300,000 loan at 6%).

This seems counter-intuitive, but it's how it works. Read the entertaining "Money" by JK Galbraith (who is a liberal, but it's still a decent book on the history of fractional reserve and central reserve banking). So if a bank in Ecuador decides to loan every working in town $300,000 to buy new houses, yes they have created money. As stated it's not totally available in the USA, but it over time is a factor in the money supply. Hope this explanation helps.

I'm familiar with the principle of fractional reserve banking. It's "assets", by the way, and money is created by all depository institutions, not merely money center banks. But the point of my question was that the Federal Reserve ultimately controls the money supply, chiefly through open market operations. State-chartered banks are already not directly subject to the Federal Reserve's reserve requirements and do not participate in their Treasury purchases and sales. If banks in Ecuador (including the central bank) choose to dollarize their deposits, what has essentially happenes is that a very large new state bank has appeared.

Banks in Ecuador are free to create money by lending money based on fractional reserves. However, the fact that they aren't subject to the same regulations (dissimilar reserve requirements, no Federal Reserve, no FDIC, etc.) means that a deposit in an Ecuadorian bank (or a negotiable instrument drawn on an Ecuadorian bank) will be worth less to the outside world, because its value must be discounted by the risk that the bank will default upon it. Consequently, the amount of "dollar money" that an Ecuadorian bank has managed to create is diminished with respect to the outside world. These funds are not discounted when they circulate inside the Ecuadorian economy, but that makes little difference to us or to the rest of the world.

So the point of my question was that the United States government still retains the power to create dollars for purposes of the American economy, through printing physical cash - which as you pointed out is an essentially trivial amount - and through engaging in open-market operations. While banks in other countries can attempt to multiply the dollar supply through relending dollars, the multiple isn't reflected here because the funds end up being discounted owing to the risk that the bank won't produce the dollars upon request.

If Mexico dollarized, the same thing would happen. So it's really nothing for us to worry about.

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.