Michael Peterson
But the decree by El Salvador’s president Francisco Flores establishing the dollar as a legal unit of currency from the beginning of next month is significant for two reasons.
| Steve Hanke | ||||||
First, El Salvador has become the first Latin American nation to join the dollar bloc at a time of its own choosing. The president claims to have had the dollarization decree ready in his desk for the past eight months.
Unlike Ecuador or Argentina, El Salvador is not suffering a banking or currency crisis (Argentina set up a currency board in 1992 to stave off hyperinflation). The Salvadoran currency, the colón, was at a steady exchange rate of 8.75 to the dollar for much of the 1990s and the banking sector is strong by Central American standards. El Salvador has long held sufficient foreign reserves to allow it to buy back all the local currency in circulation.
The presidential decree is widely seen as a measure to kick-start an economy that has stubbornly failed to grow by more than 2% or 3% a year. Faster growth is essential if it is to overcome the legacy of its bitter civil war in the 1980s.
The country remains poor by Latin American standards and is among the region’s most violent: few weeks pass without the kidnapping of a member of the country’s elite. The economy is heavily dependent on agriculture but exports have stagnated in recent years.
El Salvador’s new currency regime will also be rather unlike the one introduced in Ecuador. From next year, not only will Salvadorans be able to settle transactions in dollars, they will be free to use euros, yen or sterling if they prefer. “El Salvador has gone furthest towards something I have been advocating, which is a competitive currency regime,” says Steve Hanke, professor of applied economics at Johns Hopkins University.
Although the colón will not be abolished, it will survive only in name. Its exchange rate will be fixed permanently to the dollar.
Everyone, including public employees, can choose to be paid for their goods and services in either local currency or dollars. The president has said that he wouldn’t object to receiving the presidential salary in greenbacks. The colón seems doomed to become a collector’s item.
And that is the fate Hanke predicts for other “half-baked national currencies”.He says: “The truly significant story here is unofficial dollarization. This has been going on since the early 1990s and it has greater momentum behind it than most economists detect. All of Latin America is unofficially dollarized. Everyone stays away from local money if they can.”
| Francisco Flores | ||||||
The great benefit of removing official restrictions on the use of the dollar – at the cost of removing the option of devaluation – is lower borrowing costs for local individuals and companies. Already, some banks in El Salvador have started offering loans at interest rates comparable with those in the US, rather than the 17% or more that local-currency loans have previously attracted.
If lower interest rates revive El Salvador’s sleepy economy that will not go unnoticed in neigh-bouring countries.
“Along with more unofficial dollarization, I expect to see official dollarization of most of Latin America within five to 10 years,” predicts Hanke. “The first dominoes to fall are likely to be in Central America.”
