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Ecuador & the Dollar

What impact would there be if Ecuador abandoned the U.S. dollar?

Since 2000, the US dollar has been Ecuador’s currency. Could it be that now Ecuador and the dollar might part ways?

One thing for sure…whatever paper currency Ecuador uses…its real currency is the sweetness of its people. Here is Merri and me with the staff at our hotel, Meson de las flores.

ecuador-dollarization

Many readers have written and voiced concern that Ecuador might stop using the US dollars as its currency and return to a new sucre.

This may or may not happen.  President Correa has stated that Ecuador will continue to use the US dollar as its currency.  I previously did not think it would, until recently President Correa vowed again that Ecuador would continue to use  the US dollar and threatened to jail those who spread any rumor that Ecuador would leave dollar.

Lesson one of our Multi Currency Investing course points out that a general rule of currency investing is to expect a currency to devalue (or in this case change) soon after the responsible government swears that it will not.  

Perhaps.

The current strength of the greenback alters the fundamentals.  If the dollar remains strong it is more likely that Ecuador will go off the dollar.

A continued low oil price could also have an impact on a decoupling decision for two reasons.

First, Ecuador’s President Correa will be under extreme pressure to deliver local promises he has made to the public.  Without high oil prices he has no money to deliver the goods.  His public excuse could be to blame America and the US dollar.  A return to the sucre would allow Correa to print money he needs for local promises right now.  This would only give him a short term boost but if he is desperate this might happen to make him look better.

Secondly, low oil  prices will diminish Ecuador’s foreign exchange reserves and the nation’s ability to pay foreign obligations and debt.  Correa has proven he is willing to jilt long term obligations.  A bond default slams the door in the face of someone who gave you something in the past.  However it is a bit easier to beat up on creditors of the past than those you need to deliver goods now or in the future.  If you do not pay them, they stop sending the goods!

Correa will not want the country running short of the supplies it needs to run on a day to day basis.

Let’s watch for Ecuador’s  reserves versus its short term obligations as an indicator of when Correa might be forced to pull the dollar plug.

If Ecuador and the US dollar do part, we must ask, so what? For many, this switch back to the sucre would be good.

When Ecuador originally dollarized those who suffered most were the urban poor and citified middle class.  When the sucre was Ecuador’s currency and it devalued… wages were always raised at the same time. This meant that basics like food, clothing and subsistence shelter did not really cost more. Inflation at the base level was not real.  Certainly Western imported goods cost more…like TVs, cars and computers.  This mattered little to the urban poor because they never had a chance for this stuff anyway.  The middle class emigrated in droves to Spain and Italy.

Dollarization made inflation real!  Politicians could print more sucres to raise wages with inflation…but they could not print more dollars.  The poor in the city reeled.

The poor in the country who worked in agriculture did well though.  The price of crops rose.

Then the US dollar began to collapse versus other currencies.

The falling dollar helped create business opportunity.  One friend who owns a flower exporting business told me that the flower business in Ecuador was good due to the dollar fall versus other Latin America currencies, especially the Colombian peso. Colombia is one of Ecuador’s largest competitors in roses and bananas, two of Ecuador’s largest exports.

ecuador-holiday-roses

The cost of Ecuadorian products became lower even in the U.S. when compared to products from countries (such a Colombia) where the currency had strengthened against the dollar.

As the dollar falls versus other Latin America currencies, Ecuadorian products become less and less expensive in global terms.

Now of course the dollar has gained strength and this hurts Ecuador’s export potential.  The strong dollar is the rock…the low oil prices…a hard spot.  Correa and Ecuador’s economy are caught between them.

Also a new sucre, though less convenient,  would probably be good for expats.

Great exportable art like this will cost less if there is a new sucre and if it devalues versus the dollar.

Ecuador-art

Certainly the sucre’s last collapse made life increasingly inexpensive.  When Merri and I first arrived in Ecuador, one dollar bought about 3,000 sucre.  Then the sucre began to fall.

By late 1998 the sucre’s decline exploded, leaving the sucre in free fall. In February 2000 one U.S. dollar was worth 25,100 sucres. The currency had nose dived 67% through a disastrous 1999.  The value of the sucre then plunged 20% more in less than a week to 29,000 sucres per dollar.

The collapse of the currency created national financial ruin. The economy shrank 7%. Inflation topped 60%, the highest in Latin America in 1999. The country ran out of gas. The biggest banking scandal in Ecuador’s history made $700-million disappear from more than 750,000 accounts. This brought the failure of more than a dozen other banks and triggered a political and economic crisis that brought the entire country to its knees.

For expats with income or savings in U.S. dollars or other hard currencies, living became extremely cheaper and cheaper and cheaper.

For example I had this suit made in Cotacachi for $132.  If a new sucre is introduced and it drops in value to the dollar. that suit could cost even less.

Ecuador-textiles

Those who export carvings from this master carver would pay less for the wood work.

Ecuador-wood-carver

Wonderful ceramic work like this would cost less…good new for those who export from Ecuador.

Beautiful products like this would cost less.

Ecuador-pottery

If a meal had cost 15,000 sucre ($5) and rose to 45,000 sucre, the price in US dollars feel to less than two dollars.

If you live in a country with a weak currency and your investments or pension income is in a stronger currency, your cost of living normally falls as a currency disintegrates. For example if you live in Ecuador and it keeps the US dollar as its currency, but invest in currencies that rise against the dollar, your cost of living will drop!

There is a caveat.  If Correa pulls the buck and replaces it with a new currency…he could get it right…or at least righter than the US government is with its currency.

Ecuador’s debt, as a percent of GDP, is tiny compared to the debt of the USA. Recent statistics show that Ecuador owes about 21% of GDP. The US owes 400% of GDP.   Many emerging currencies (Thailand, Brazil. Colombia as examples) rose as much as 25% against the dollar in recent years. They recently feel in 2008 but as markets come back to their senses may rose again.

The US dollar has been strong in the last year but fundamentals suggest it will fall.

A new sucre could rise against the US dollar as well.  In this scenario, all the goods above would cost more!

In this case expats who hold or earn only US dollars should have multi currency diversification.

Finally, if a new sucre is reinstated, what will happen to the value of property in Ecuador.  It will rise about the same as the sucre’s fall as it did prevously… but distrtions will create more opportunity for astute investors.

Until next message, good living…wherever you are!

Gary