Ecuador: Economist defends dollarization, concerned over national digital currency

Ecuador’s prospects/ Dr. Larry White -Professor of Economics at George Mason University./ freebanking.org December 4th, 2014

While we celebrate Ecuador’s fifteen years of success with dollarization, and think about extending it, we must take note of two dark clouds on the horizon.

First, Ecuador still has a central bank. Although the BCE is presently precluded from issuing paper currency, it continues to be assigned by public law “the responsibility of implementing the monetary, credit, foreign exchange and financial policies formulated by the Executive.” Why? We should have no doubt that the Executive would dearly love to once again have a monetary policy to conduct. We should expect the BCE’s own funcionarios to seek to enlarge the scope of the bank’s discretionary powers, if only in the sincere hope that they could do more good. But we know that the direction of greater discretion in monetary policy leads back toward the conditions of 1999. With dollarization, a central bank is completely unnecessary.

Second, I have been learning with concern – as I am sure you have – about the plans of the national government of Ecuador to issue its own digital mobile-phone currency. The idea is for the Banco Central to issue dollar-denominated electronic credits that customers of the government-owned mobile phone network CNT can use to make payments by phone. As the Associated Press reported August 2014: “Such mobile payments schemes are already popular in African nations including Kenya and Tanzania, where they are privately run. The new currency was approved, and stateless crypto-currencies such as Bitcoin simultaneously banned, by Ecuador’s National Assembly last month. The official in charge of the new currency, Fausto Valencia, said the software is already used in Paraguay by cellphone companies.”

There is no reason to believe that a national government can run a mobile payment system more efficiently than private firms like Vodafone (which originated and runs the successful M-Pesa system in Kenya) and Tigo (which runs the Giros Tigo system in Paraguay). Why not let the private mobile phone companies also compete to provide mobile payments in Ecuador, issuing their own dollar-denominated account credits? Instead they are banned unless they use the government’s credits. Such a ban is costly to ordinary consumers. Evidence from around the world shows that payment by mobile account credits is the type of service that firms in a competitive market can produce, will produce when there is a normal rate of return to be earned, and produce at lower cost than state-owned enterprises.

The government insists that its new system will be “voluntary.” But when the state gives itself a monopoly on a service, blocking individuals from the voluntary choice to use another provider, the option to “take it or leave it” is not fully voluntary. If the government sincerely wishes to help the poor and unbanked, it should let private providers enter the competition, which will drive down the fees that the poor and unbanked will have to pay.

It is very curious that a law supposedly seeking to provide the poor with low-cost access to payment systems would ban Bitcoin. (The only other country in South America to ban Bitcoin appears to be Bolivia.) In countries that receive income from remittances, Bitcoin has the potential to noticeably increase national income by lowering the cost of remittance. What the family in the home country receives is much closer to the amount that the worker abroad has paid to send when the worker uses Bitcoin rather than Western Union or another old-fashioned high-priced system. Researchers at the Pew Center in the United States estimate that remittances account for about 3% of Ecuador’s GDP. In 2012 the average Ecuadoran working in the United States sent home $2607 dollars. So this is not a trivial matter. Bitcoin remittances could contribute many dollars to the pockets of Ecuador’s poor.

A report from the news service Payment Week says of the government’s mobile payment project: “The currency will serve as… a way for the country to regain some control over its economic system. The production of the new currency would completely depend upon demand.” But these two sentences can’t both be true. The new system can’t both allow the government to “regain some control” over the economy and also make the volume of credits “completely depend on demand,” which implies that the government is passive and exercises no control.

Given that is doesn’t make economic sense, why does the government want to issue mobile payment credits as a monopolist? It seems likely that the project is meant as a fiscal measure. One million dollars held by the public in the form of government-issued credits is a million-dollar interest-free loan from the public to the government. According to Payment Week, “The government has said it won’t use the [new] currency to fund public spending,” but this is hard to fathom. If the project makes a profit, where else would the profit go?

If the government can make a profit at mobile payments, even though they have no expertise or comparative advantage in the area, surely Movistar or Claro can operate more efficiently and make larger profits, even while charging lower fees. Why not let the private sector operate in this area? Why not let the public choose which firm has the most reliable and trustworthy service? If the government desires to subsidize the use of the service by the poor, it has the option of issuing them vouchers. It need not provide the service itself, and certainly not as a monopolist.

Personally, I would find dollar-denominated account credits that are claims on Movistar or Claro more credible than claims on the government of Ecuador. After all, unlike the government, neither company defaulted on its bonds in the past 12 years. Claims on private companies are legally enforceable. The company cannot suspend payment or devalue its IOUs without taken to court and forced to pay or dissolve. Competition for business compels payment firms them to worry about reputation, and so compels them to manage the business so that their readiness, ability and willingness to pay is not in doubt. A government agency, by contrast, cannot be sued for breach of contract, and has no concern about maintaining a good reputation when it has no competitors. If CNT or the BCE decides to devalue mobile credits against the US dollar, holders have no remedy in court. People who are thinking about holding the credits need to consider the default risk. The “backing” requirements in the law are completely toothless against a government that chooses to default.

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In sum, there is no plausibly efficient or honorable reason for the Ecuadoran government to go into the business of providing an exclusive medium for mobile payments. Consequently it is hard to make any sense of the project other than as fiscal maneuver that paves the way toward official de-dollarization. I gather that President Correa does not like the way that dollarization limits his government’s power to manage the economy. He has compared the limitation to “boxing with one arm.” But as I have already emphasized, retiring the government from boxing against the economy by means of money-printing is precisely dollarization’s great virtue. Read Article