In Gold We Trust
The lockdown gave us all time to reflect on what the future may hold and how we could potentially reshape that future for the better. In my period of confinement and reflection, I decided to research and write a series of articles focusing on how Ecuador can best navigate the post-pandemic economy and set itself up for success.
The first article of this three-part series, titled In Gold We Trust, argues that, although Ecuador should maintain its dollarized economy, the Central Bank should introduce a limited digital currency – backed by gold – to operate in parallel. This new digital currency, or Ecuadolar, will promote greater flexibility in our currency market and thereby support the competitiveness and attractiveness of the Ecuadorian economy to foreign direct investment (FDI) and grow our exports exponentially.
Between a Rock and a Hard Place
Monetary policy and fiscal policy should work together. When Ecuador adopted the US Dollar in 2000, it was meant to set the foundation for growth and stability for the century ahead. But adopting the greenback can only take us so far, especially when we fail to adopt suitable economic policies to support growth. Unfortunately, in our story, history continues to repeat itself where government-after-government has operated fiscal deficits and Ecuador today finds itself with the same poor liquidity conditions that were around many decades ago. This cycle leads to more debt and greater fiscal deficit, with external debt ballooning beyond 50% of GDP. All this occurred despite Ecuador having received billions of dollars in exports. A common-held view – one which I support – is that the proceeds were generally poorly invested.
What this should tell us is that the fixed exchange rate granted by dollarization has not prevented excessive fiscal spending, public deficits and the need to rely on external debt. Ecuador has only recently renegotiated external debt of roughly US$ 18 billion until 2040, and we will continue to ask the IMF for more.
We are stuck in a tough place: our fiscal policy is stretched to its limit and at the same time we are at the mercy of a US Dollar that we cannot control. The impossible trinity is to have free capital flow (absence of capital controls), a sovereign monetary policy (which we do not have), and a fixed exchange rate.
What we have been doing in the past has not worked well enough. Why don’t we use the tools of the future to craft the future Ecuadorian economy?
The Digital Revolution
Of course, we need the stability of dollarization and I support the retention of the US dollar for the domestic economy. But to improve our competitiveness and trade balance will require greater flexibility in exchanges rates, and to achieve that we should develop a new digital currency to be issued and governed by the Central Bank, backed by gold, and used primarily in the realm of foreign trade.
The most well-known digital currency, Bitcoin, has a fixed supply which helps promote its credibility and public trust. In a similar manner, I propose that the Ecuadolar would be capped in amount corresponding to fixed gold reserves (which I believe should be the equivalent of US$ 4.5 billion, a level equivalent to the foreign exchange reserves held when oil prices were high). Setting a limit in this way and protecting the issued Ecuadolar 100% by the corresponding gold reserves would support public trust and credibility for investors. The gold reserve would be financed via an IMF approved credit facility scheme under a rapid financing instrument (or ‘RFI’).
But unlike Bitcoin, the Ecuadolar would be state-backed and the Central Bank of Ecuador would have the ability to monitor the currency and the financial markets would set-off the exchange in order to serve foreign trade. The exchange rate of the digital Ecuadolar would be flexible and established daily, based on the rate of the US Dollar with respect to SDR (special drawing rights), as published on the IMF website. The SDR is an international asset created by the IMF to supplement the official reserves of countries. Since 2006, its value is determined by a basket of currencies made up of the Yuan, Euro, Yen, British Pound, and US dollar (considered as reserve currencies in the IMF). As of September 16, 2020, the value of one SDR is equivalent to USD $1.4168.
The Ecuadolar would allow for greater flexibility in exchange rate policy that would foster productivity, encourage export growth, and consequently economic growth over the decades to come. With this system, the financial markets and the Central Bank monitoring the exchange rate would stimulate economic growth by making exports cheaper and imports more expensive. It simply cannot do this under dollarization.
Post-Pandemic and the Mining Boom
According to some economic analysts, the COVID-19 pandemic will cause the Ecuadorian economy to contract by up to 12% in 2020. The years to come are still uncertain. But the Ecuadolar and the foreign exchange policy it represents will encourage exports and help fight unemployment, which in June registered the highest rate this century at 13.3% (Gestion magazine).
But there might be a light on the horizon and the projected mining boom presents a unique environment into which the Ecuadolar could be introduced. According to reports on the mining sector from the Central Bank of Ecuador in July 2020 and the magazine Vistazo-Enfoque during 2018 and 2019, FDI into Ecuador of US$ 1.19 billion came mainly from Australian and Canadian capital and was invested into the mining sector. This has set the foundation for a mining boom that could see the Ecuadorian economy through the worst of the pandemic and set the country up for a post-pandemic boom, similar to the Australian experience following the Great Financial Crisis of 2008-2009. Although feasibility studies continue, the Australian Soldgold mining company has reported that its tenement in the Alpala reserve (Imbabura Province) has the world’s largest underground silver mine, third largest gold mine, and sixth largest copper mine, with aggregate estimated reserves of US$ 100 billion. In the next 5 years, Ecuador will receive about 4% of GDP from the mining sector and this will continue to increase.
The mining boom and its associated increase in trade and foreign exchange policy can be leveraged by the Ecuadolar as it provides a limited currency framework within which foreign trade can occur at rates attractive to investors. The future of our economy should be supported with digital tools of the future.
When we consider the story of Latin American emerging markets such as Brazil, Mexico, and Chile, they have focused on economic policies that foster FDI and export growth with a flexible exchange rate and supportive bilateral trade agreements, and they have seen their economies grow accordingly. Across the ocean, Vietnam has had a similar experience, attracting FDI and seeing its exports reach US$ 264 billion in 2019, 12 times that of Ecuador in the same year. The Ecuadolar could be our way to increase the competitiveness of our exports and a corresponding increase in FDI. However, in order to have free capital flows, the foreign currency outflow tax should be eliminated.
Let us take charge of our future. We cannot hope for the US$100 bill to save us, even if it is engraved with ‘In God We Trust’.
To that, I say, In Gold We Trust! Dollarization is an essential part of our economic future, but let us create the digital Ecuadolar, backed by gold, to be used primarily for foreign trade and provide the flexibility within which our exports and our economy can thrive.
Eduardo Salgado Manzano