Why Ecuador Uses The Dollar? : The Indicator from Planet Money One of our youngest listeners asked us why Ecuador changed its currency to U.S. dollars, so we found out!
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Why Ecuador Uses The Dollar?

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Why Ecuador Uses The Dollar?

Why Ecuador Uses The Dollar?

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BIANCA BARREL: Hi. My name is Bianca Barrel (ph), and you're listening to THE INDICATOR FROM PLANET MONEY.

STACEY VANEK SMITH: Bianca is 9 and a half years old, and she is an INDICATOR listener. We get mail from a lot of listeners. And we love this. It's one of our favorite things. But the email from Bianca stood out to us.

CARDIFF GARCIA: Yeah. That one was special.

VANEK SMITH: It was. Yeah. We heard actually from her father, Robert (ph). And he wrote us saying that Bianca listens to THE INDICATOR and does a lot of other things too, apparently.

GARCIA: Super precocious young lady.

VANEK SMITH: She speaks Spanish and Mandarin. And she does jiujitsu, and she plays the violin. And also, she loves economics.

GARCIA: Yay.

VANEK SMITH: Yay.

GARCIA: And she had an economics question for us. And we figured sure, yeah, we'll do a whole INDICATOR answering that question. Here it was.

BIANCA: When I went to Cuba, Mexico and Dominican Republic, my parents had to change the currency. But when we went to Ecuador, we didn't have to change the currency. Before in Ecuador, they had the sucre as their type of money. Now they have dollars. How did they get the money for Ecuador without causing inflation? And doesn't it affect the money supply here in the USA? And how did they get the money there? How - and how come they don't do it for other countries, like Dominican Republic and Mexico and Colombia?

VANEK SMITH: Oh, my gosh.

GARCIA: Wow.

VANEK SMITH: Bianca for president.

GARCIA: Yeah. We...

VANEK SMITH: At least some day, right?

GARCIA: (Laughter) We heard this super-smart question. And after we listened to it, Stacey and I were like, we'll get back to you.

VANEK SMITH: We...

GARCIA: Got to do a little research.

VANEK SMITH: It's not that we don't know the answer because we do. It's just that, you know, we want to prepare something special for you (laughter).

GARCIA: And we did. Right after the break.

(SOUNDBITE OF MUSIC)

VANEK SMITH: So Bianca's question. Now, there are a few parts to this question. So we wanted to break it down so we could answer it properly. The first, why does Ecuador use the dollar now instead of its old currency, the sucre? Second, where did Ecuador get all these dollars? Third, does it affect the money supply in the U.S.? And fourth, why don't other countries use the dollar?

To answer all of the parts of this question, we wanted to go to an expert. So we called up an economist who has studied Latin America and in fact just got back from a trip to Ecuador.

SEBASTIAN EDWARDS: I'm Sebastian Edwards. I'm the Henry Ford II professor at UCLA.

GARCIA: OK. So Sebastian, first of all, that - that's a pretty smart cookie, isn't she?

EDWARDS: Oh, amazing. And 9 and a half years old, that's...

GARCIA: (Laughter) I know.

EDWARDS: I wish my MBA students asked that kind of question.

VANEK SMITH: So we started by asking Sebastian why Ecuador started using the dollar back in the year 2000.

EDWARDS: I mean, 2000, just before getting rid of the domestic currency - which, as Bianca said, was called the sucre - there was a 100 percent inflation. We think in this country that 3 percent, 4 percent is pretty high. We like, like, 2 percent. So just think what it is, 100 percent inflation.

GARCIA: That's amazing. That means prices were doubling every year.

VANEK SMITH: Ecuador had a big inflation problem. And this was not the first time.

EDWARDS: The problem in Ecuador was that this was recurrent. It happened every so many years.

GARCIA: Back in the days when Ecuador's currency was the sucre, these inflation problems just kept happening. Remember, inflation is when prices go up. And when prices go up by too much, people get worried because it means they cannot buy as much stuff with the money they make at their jobs. And it's just really unsettling.

VANEK SMITH: And Sebastian says a big reason this kept happening was that the country's central bank was not doing a very good job. The Ecuadorian central bank had the ability to print money, like any other central bank. And when it printed too much money, that meant there were too many sucres flowing out around in the economy to be spent on the same number of goods. So the price of those goods went way up. That is inflation.

EDWARDS: So what Ecuador did is that its central bank could not discipline itself. And more than that, it pretty much responded to the will of politicians. Which is very different from what we do in this country, where the Federal Reserve is a independent entity and where the members of the Fed cannot be fired, or at least not easily, by the executive, by the president. So that wasn't happening in Ecuador. So they were printing too much money, and they were - the central bank was abusing its power and generating these bursts of inflation every so often.

GARCIA: Ecuador wanted to end these bursts of inflation. So it's politicians looked at another Latin American country that also uses the U.S. dollar - Panama. And Ecuador's politicians noticed that Panama did not have these inflation problems the way Ecuador did. And they figured, we can do that too. So they did.

VANEK SMITH: Now, Bianca also asked us, how did they get all the dollars down there? That is a great question. Remember, Ecuador cannot create U.S. dollars. Only the U.S. can create U.S. dollars. So Ecuador had to bring U.S. dollars in from the U.S. Here's Sebastian.

EDWARDS: That is generally done through an agreement between the local authorities and the Federal Reserve. So the dollars are shipped in. And they are put into ATMs and into banks. And then people have a period of time when they can exchange at a given ratio their local currency, sucres, for dollars.

GARCIA: Yeah, but there is another important question here, which is doesn't Ecuador have to pay for those new dollars? The answer is yes.

EDWARDS: When you don't have a currency of your own and you use the dollar, you cannot print dollars if you're Ecuador. So in order to get more dollars, you need to sell to the U.S. more bananas or more chocolate. Ecuador has a wonderful chocolate industry that - it's being developed now. Or you have to sell more oil than what you import. So you have to run a surplus in your international trade in order to get in more dollars than what you're paying out so that the economy can expand and have more dollar liquidity.

VANEK SMITH: In other words, Ecuador gets these new U.S. dollars by selling its goods outside of the country in exchange for U.S. dollars - things like oil, mainly, but yeah, other stuff like chocolate and bananas. And you know what? Dollarization has mostly worked out for Ecuador. Inflation has been low and stable ever since Ecuador made the switch. And, as Sebastian told us he learned from his recent trip, Ecuadorians seem to be pretty fine with it.

EDWARDS: I asked everyone I met - waiters and waitresses in restaurants, taxi drivers, everyone - whether they wanted to go back to the sucre. And I could not find a single person.

GARCIA: Really?

EDWARDS: Not one. Maybe a couple of theoretical economists. But common people in the streets of Ecuador just don't want to do it. They are happy with the way the system is working. They like stability and predictability. Prices are not going to double overnight or in a year time as they did in the past.

GARCIA: Bianca also asked if Ecuador having dollars affects the money supply in the United States. And the short answer is not that much. The Federal Reserve is supposed to create an appropriate amount of dollars for the U.S. economy. And some of those dollars do end up in Ecuador. And then they stay in Ecuador, which does make the Fed's role a little trickier. But the U.S. economy is almost 200 times bigger than Ecuador's economy. So in practice, it just doesn't make that much of a difference.

VANEK SMITH: Finally, Bianca asked us why other countries don't also switch to the U.S. dollar. Now, remember, using the U.S. dollar now means that Ecuadorian politicians cannot print more money whenever they want. That is what led to all the inflation. But when their economy is in a recession, that is when you want to be able to print more money to get the economy moving again, like we did in this country during the financial crisis. Ecuador can't do that. So its recessions might be deeper and might last longer when things start going bad. Other countries did not want to give up that option to fight a recession the way Ecuador did.

GARCIA: So it's a tradeoff. Switching to the dollar can bring more stability, especially to countries with bad central banks. But it can also mean sacrificing the ability to manage your own economy when things get bad.

VANEK SMITH: And that's it. That's what we found. So we wanted to call Bianca up and give her our answer.

GARCIA: Hey, Bianca.

VANEK SMITH: Hi, Bianca.

BIANCA: Hello.

VANEK SMITH: Hey, how's it going?

BIANCA: Good, thank you.

VANEK SMITH: OK. So did we answer your question?

BIANCA: Yes. Was very interesting.

VANEK SMITH: And we had so much fun looking for the answers.

BIANCA: Thank you for answering my question.

(SOUNDBITE OF MUSIC)

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