The Dollarization - Essay Example

?Report on dollarization. What does this term mean and how has it worked in a country that has adopted it (e.g., Ecuador)? Are there other countries considering it? Summary: This article is going to deal with the concept of dollarization and purports to brig about the meaning and explanation related to the concept. It will touch upon the aspects like that of the need to dollarize the currency of a particular currency, the types of dollarization that are followed, the ways to address the issues with regard to dollarization, the methods to streamline the fiscal model of a country. This particular paper will bring out the main issues related to the concept and also provides information as to who will be affected by it. Pros and cons of the dollarization concept is also adequately addressed in the paper that will provide you with the true scenario with regard to the concept. For the purpose of analyzing the system of dollarization, the paper will be making use of the country, Ecuador, as a model country that has already undergone dollarization. The country Ecuador will be critically analyzed and the social, economic and political impacts that the country faced owing to the dollarization will be provided with sufficient resource to substantiate it. It will also touch upon other countries that are wishing to and are in the queue to the process of dollarization. Thus this paper intends to bring out the actual model as to how a dollarized nation keeps on pace with the world economy and analyzes whether it has provided with the necessary benefits that it claims to provide. Ross, W. and Jaffe, J. (2007), it is absolutely necessary to take care of the finance aspect o of country in order to make is stand tall in the global level. The world is seeing a lot of changes with regard to the monetary and fiscal policies in order to regulate and also to stabilize the economy. There are many countries in the world that is going for a drastic change with regard to their policies on finance that is causing some ripples across the world. One such monetary regulation policy that has come into parlance is that of the concept of Dollarization. It is a kind of policy followed in many of the countries in order to bring in control their economic condition. In this kind of set up, the country will abandon their current money or currency system and makes use of a foreign currency for their daily needs. Everyone in the country including the Government will make use of this currency system in order to bring in more value to their country and also to curtail the high plunging inflation rates that are finding its place through the economy. The concept of dollarization has already garnered enough attention and recognition all throughout the world. The best part about this concept is that it will not only help in keeping the inflation rates at bay but also will help in boosting the economic condition of a particular nation. In this scenario, the domestic currency will lose its value and the foreign currency will gain prominence over the current one and will be considered valid for any transaction through the country. Dollarization does not mean that only dollars are needed to be used as the currency. It is a general term and it is up to the country that is scouting to choose a particular foreign currency that it wishes to follow or adopt. The country will undergo some process and analyze thoroughly to see which of the foreign currency will suit their domestic needs and then choose over the most appropriate among the many lot. Earlier the concept of dollarization was used unofficially by many countries in order to meet with the growing demands and necessities. It was followed on an individual basis and this scenario has changed. Now even the governments are adopting the foreign currency and are making use of it officially in place of the domestic currency. The government of a particular country will announce the necessity to change to a particular stable foreign currency in order to prevent itself from breaking down in terms of the financial conditions. Yet another effect of a nation that is adapting to a foreign currency as its own is that the country will have to give up all power to vary its exchange rate, with its financial system being hooked to that of the other country. Main issues: 1. What lead to dollarization in the country called Ecuador? 2. Does dollarization curtail the inflation rates and restore the stability of economy in Ecuador? 3. What is the political, economic and social impact of the dollarization in Ecuador? 4. What are the advantages and disadvantages that are associated with that of the dollarizaion in Ecuador? Analysis: The Republic of Ecuador is one of the representatives of that of the Republic of South America. The economy of Ecuador is very much dependent on the resources that are available there like that of the petroleum, gold and timber. One of the greatest contributors to the economy of the nation is that of the crude oil in which the country is one of the major exporter. Thus the economy of the country will undergo great fluctuations that are very much dependent on the economic condition of the world. The place is one of the worst hit when it comes to inflation because of the constant up and downs of the economy. A sharp drop in oil price or a great surge in that of the oil price will cause a great impact in the whole of the country and Ecuador needs to adapt it according to such situations. This has lead to a greater inflation in the country that went beyond control. In order to address the issue and to make sure that the economy of the country is stabilized and also streamlined at the same time and clearer cut approach with regard to monetary or fiscal policy was mandated. The major problem rose with Ecuador depending on oil that made the nation be at the mercy of fluctuations in global marketplace prices. The oil market came to meet a drastic crashed in the early 1980s that lead to worsening of situation in the country.The instable economy in the country led to a condition where the contraction of the GDP touched some 7.3% associated with a yearly inflation rate of 52.2% and also that of 65% devaluation of the national currency called Sucre. In such a scenario the US dollars were started to be used in place of the domestic currency Sucre. In due course of time, the American dollar gained prominence over the local currency and the President of the nation announced the use of the US dollar from the year 2000. Ecuador officially announced the usage of the US dollar. This step was taken by the government to make the country reliable on a stable economy like that of the American dollars. This way the inflations rate were curbed to a great extent and the economy of the country saw a fresh stability in it course and served the people better than before. Many theories associated with that of the fiscal control provides that dollarization is the best method. Yeyati and Sturzenegger, (2003) states that “Without any doubt, fiscal reform must be part of any dollarization process because one of the much proclaimed goals of dollarization is to bring about a substantial reduction of the country risk premium and borrowing costs dollarizing countries face in international capital markets” Added to the oil price crash there were other scenario that led to the downfall of Ecuador to a very great extent. Many rulers and government came and went but the economic situation of the country went worse from time to time. There were frequent volcanic eruptions taking place, a bad weather scenario hit the nation, budget crisis rose to a greater level, currency devaluations happened and also earthquakes shattered the nation. It was felt worldwide that this small nation is going through a greater extent of turbulence and turmoil in the process. The political and economic instability of the country reached its zenith. Ecuador’s financial system was sent into a jiffy with the Sucre touching hyperinflation, the country did not pay foreign debt, and Ecuador’s entire banking sector crashed that led Ecuadorians rushed to put their financial records into a more steady currency in the form of US dollars. This is when the Mahuad administration called for dollarization of the currency. The move brought in widespread dissatisfaction among a large crowd of people that led the nation to a protest mode. Ecuadorian government started to exchange Sucre for dollars at the rate of S/. 25,000 = $1. After this scenario, the Ecuadorian administration would only make coins in equal value to the American currency, nickel, dime, quarter and half-dollar. Thus started following there currency value to bring stableness. In a short span of time, the circulation of Sucre was completely stopped and the new arrangements with some international creditors were made to begin a new economy in Ecuador. As soon as this arrangement was made, there were slow but steady developments seen in the economic condition of Ecuador and the country came to be economically stable in the form of American dollars. The scheme was successful and the country came out from the drastic situation in a matter of few years. The year 2004, Ecuador economy grew by a striking 6.9% which can be attributed to the recent opening of a new oil channel that more than doubled Ecuador’s oil production. In the year 2005 the recorded rate of economic growth was 3.9%.  When we take the stance of political, economic and social stance of the nation Ecuador after the process of dollarization, there has been a lot of change that are both positive and negative but the positives seems to be more than that of the negative outcomes. Let us see Ecuador’s stance in politics after dollarization. It is to be noted that the decision to go for the dollarization is a great political move that has facilitated the government to move about in the country after that. The terrible fall of Sucre currency had a devastating impact on the government which was brought into a tight corner. There is a lot of political meaning hidden behind the economic move of dollarization. It was analyzed and proposed by various thought leaders that it was a great move to curtail the power enjoyed by the Central Bank. Renowned economic analyst Vicente Albornoz believes that dollarization helped in bringing down the authority or hold the central bank had on the economy of the country which in turn will down the power of the central government. When the concept of dollarization was introduced originally in the 90s, the banking sectors were not happy with the arrangement as the policy cut down their hold. Many sectors felt that it was the best way to divest the money in the central bank. Yet another major political consequence of dollarization is that it attempted to bring down the President and also made the public fear that the process of dollarization will end and there will be more such instability coming out of it in future as well. The dollarization brought about a great change with regard to the way the government looked at the budget settings. Social changes were immense as the economic conditions were more stabilized than earlier due to the dollarization of the process. People came in terms with the reality and realized the value of money. Though the turbulences and the turmoil that people had to face in the period of fall, it all happened to bring in a greater social set up in the future. Now with more stabilized and streamlined economical set up the people of Ecuador are able to meet up with some of their basic necessities in their day to day lives. On the economic front also, Ecuador benefited out of the dollarization process and made sure that there are external creditors and also investors invested on their economy by making use of this particular arrangement. A portfolio of large investments started coming into the nation with the coming of this new economy form in the country. Even before official dollarization came about, many stores and companies started to make the transactions by way of dollars in the 90s. The situation of unemployment in the country fell to a greater level once the dollars were brought into the picture and this served the country better than the Sucre. On the whole, the dollarization had a very great impact both directly and indirectly and brought about a major change in the political, economical and social set up of the nation overall. The concept of dollarization comes along with both positives as well as negatives and contains both the advantages as well as disadvantages associated with it. The scheme has greatly been beneficial with the growth of the economy of the country and the monitoring of the fiscal policy was facilitated. On the other hand, in the microeconomics level there were instance of high unemployment rising in the country. The stability factor just not stops with the economic stability and that if the curtailing of the inflation but goes one step forward to see whether it sufficiently addresses the question of the crux issues such as providing effective solution to the poverty condition in the country and also the equal distribution of wealth among people. The prime advantage of dollarization in Ecuador that can be derived out from the analysis is that the extensive and wild inflation rates have been efficiently addressed through this arrangement or system. Next to that, the system also provided for the overall wellbeing of the people providing them with the buying power even in such a stage. Only if the economy is stable can a country go about the strategic planning and also plans related to political, economic and social stance of the country. Long terms goals and aspirations also depends upon the stabilization factor of the currency. Prior to the stabilization move, foreign investors were reluctant to go about the system and held the Sucre is not on par with international currency, once the dollar came in, the investments also came in plenty. As per the IMF Country report, 2006, The dollarization system is also not devoid of any negatives associated with it. The Ecuadorian government will not be able to take or make a move with regard to the economic policies as its economic system is dependent on an outside currency which is a great disadvantage. The country will always be in the mercy of the stance taken by that of the foreign nation with regard to the monetary policy. The country cannot compete with its nearby nation in terms of selling products and goods as it is facing a competitive disadvantage. People will go to buy the products cheaper from a nearby entity rather than having to unnecessarily spend on the US dollars in Ecuador. Other problems included counterfeiting of coins and also unfamiliarity with the currency. Conclusion: On the whole, dollarization is one way to make sure that the economy is brought in control and that the buying capacity of the people living in inflation hit nations are maintained in order for a sustainable living. As far as Ecuador is concerned, the job scarcity is still there and the rates of interest are also high in the region. These are the problems that are found at the microeconomic level. On the macroeconomic level, the dollarization has helped to a very great extent to bring about the stabilization of the economy which was initially dependent on the oil price of the market. Once the macro issues are adequately addressed, the micro problems can also be sorted out in matter of few years but adequate measure should be taken in order to address the issue at the initial stage itself so that it does not again affect the economy in the long run. Dollarization has done more good than harm to the economy of Ecuador and thus it has definitely worked for the benefit of the nation. References: 1. Yeyati, E. and Sturzenegger, F. (2003). Dollarization. Massachusetts. 2. IMF Country report, 2006, www.imf.org/external/pubs/ft/scr/2006/cr06103.pdf 3. Ross, W. and Jaffe, J. (2007). Modern Financial Management. McGraw-Hill Irwin. Five Links: http://debatepedia.idebate.org/en/index.php/Debate:_Dollarization http://www.nytimes.com/2000/01/12/business/international-business-ecuador-s-3-top-central-bankers-quit-over-dollarization.html http://bx.businessweek.com/the-foreign-exchange-market/view?url=http%3A%2F%2Fc.moreover.com%2Fclick%2Fhere.pl%3Fr4480562569%26f%3D9791 http://www.latinbusinesschronicle.com/app/article.aspx?id=4826 http://online.wsj.com/article/BT-CO-20110415-709627.html Read More