BY SEAN HEALY
Two shockwaves have hit the Central American country of El Salvador in the first weeks of January. One, a massive earthquake which measured 7.6 on the Richter scale, struck on January 13 and killed more than 600 people, devastating much of the country. The other struck on New Year's Day and may have an even more lasting impact.
The country's right-wing president, Francisco Flores, announced plans on November 22 for a new law, the Monetary Integration Law, which would "dollarise" the El Salvadoran economy. The law would make it legal to use US dollars in all transactions alongside the local currency, the colon, and would fix the exchange rate at 8.75 colons to the dollar. Barely a week later he had rushed the law through parliament; on January 1, the law came into effect.
The immediate impact of dollarisation was chaos. The local media filled with stories of residents angry at rip-offs, especially by merchants and even banks rounding up prices and keeping the change. Finance minister Jose Luis Trigueros bravely ventured out to the supermarket, local television crews in tow, to demonstrate how easy the transition was — but couldn't even buy candy because the young woman serving him didn't recognise the US coins he was holding out.
The left-wing Farabundi Marti National Liberation Front (FMLN), the main opposition to Flores' ARENA party, opposed the law in the November 30 parliamentary vote and sought unsuccessfully to repeal it on January 5. The FMLN has now promised to file a suit in the country's Supreme Court against the dollarisation plan.
The FMLN has criticised Flores for surrendering El Salvadoran national sovereignty and control over monetary policy to the US Federal Reserve Board, which controls supply of the dollar.
The response from the trade unions has been similarly strong. A federation of government workers unions began a series of protests on January 5, holding demonstrations outside government offices.
Flores claims the plan is aimed at kick-starting the El Salvadoran economy, which has stagnated in the past two years, by ending the chances of currency instability, attracting foreign investors, particularly from the US, and lowering the cost of capital. El Salvador's interest rates are running at 15-22%, far higher than the US's, and the small size of local financial markets forces firms to borrow abroad, exposing them to considerable currency risk.
El Salvador's dollarisation certainly won the praise of those it was aimed at enticing: statements from the US Treasury, the International Monetary Fund and Wall Street were all congratulatory.
But aside from desperately seeking foreign investment, Flores also hopes the change will lock in his government's neo-liberal economic program, which has enriched ARENA's business cronies, including local bankers, but further impoverished the country's people.
His surrender of Salvadoran control over monetary and exchange rate policy, including the ability to print money to finance government spending, will make it very difficult for a future FMLN government to run an expansionary fiscal policy, as it would have to gain financing from international capital markets, an unlikely prospect.
A firm trend
Dollarisation is now a firm trend in Latin America. El Salvador is the second country to formally dollarise in the past year — Ecuador finished doing so in September — and neighbouring Guatemala has already passed a law making the greenback legal tender from May 1.
Dollarisation is also being seriously considered by the English-speaking Caribbean zone and the new Mexican finance minister, Francisco Gil Diaz, has also argued for his country to do likewise. Argentina's economy has been all but dollarised since 1991, when the government wrote into law a one to one exchange rate between the peso and the dollar, and is considering giving legal recognition to its dollar economy.
The major Third World economies have traditionally operated "soft peg" exchange rate policies, whereby central banks determine the exchange rate they want to achieve between their currency and a stronger one, usually the US dollar, and then buy and (very occasionally) sell their own currency in international markets in order to keep it at that "pegged" level.
Such a policy makes a currency vulnerable to attack by foreign speculators, however. If speculators are able to generate a panicked sell-off of the local currency by other foreign investors, they can force the central bank to sell them its foreign reserves on the cheap, in a vain attempt to keep the currency at the level of the peg.
This is exactly what happened to the Mexican peso in 1994 and to the east Asian, Russian and Brazilian currencies during the world financial crisis of 1997-98 — all came under sustained and successful attack by speculators. Defending its soft peg drained Brazil's central bank of US$56 billion in reserves within a year, according to IMF figures.
Since the crisis and the desperate failure of the "soft peg", the conventional wisdom among neo-liberal economists has reduced Third World governments' exchange rate options to two polar opposites: either a freely floating currency, in which the central bank makes little or no attempt to keep it at a set level, or a "hard peg", an irrevocable linking of the local monetary unit with a stronger one, either by law or through adopting the stronger currency outright, as in dollarisation.
But neither policy course offers much chance of improving the people's welfare. Both policy courses only further Third World countries' dependence on First World central banks and financial markets.
The perils of a freely floating currency are obvious: it offers no protection whatsoever from the increasing volatility of international currency markets. Countries which choose a free float, as Brazil and Mexico now have, thus become painfully dependent on their own "credibility", a financial press euphemism for the good will of the major foreign investors. Any false move and, instantly, the currency is sold down, inflation kicks in and capital flees.
Ending instability?
The appeal of a "hard peg" is that it promises to do away with this instability, most especially the threat of the hyperinflation which has long plagued Latin America. Third World governments trade in their currencies for the unassailable "credibility" of the greenback and the US Federal Reserve.
The ability of the "hard peg" to deliver stability and economic growth is questionable, however, as delivery is highly dependent on local elites' disavowal of profiteering, something which very rarely happens.
Even more importantly, the "hard peg" severely restricts anti-recessionary policy options. Monetary policy — such as currency devaluations, drops in official interest rates and expansions of the money supply — is completely closed off and handed over to the US Federal Reserve. Fiscal policy — such as running government deficits to stimulate demand — is severely restricted, both by the necessity to keep large foreign currency reserves in order to cover demand for US dollars and by countries' massive debt repayment commitments.
The price, then, of dollarised "stability" is that any economic shocks can only be dealt with by deflation — more specifically, by a sharp reduction in workers living standards. Austerity becomes the only policy option.
Since then-president Jamil Mahuad announced Ecuador's dollarisation plan on January 9, 2000, for example, the impoverished Andean nation has experienced its worst-ever inflation rate — 91% — largely due to the local elite running up a 50% US dollar loan default rate and stripping domestic banks of assets.
According to one economist interviewed by the Inter Press Service on January 10, "inflation did not soar even higher simply because buying power shrunk" due to the IMF stipulations which accompanied dollarisation, which included an 80% rise in the price of cooking gas, the sacking of 26,000 public sector workers and a four-step 50% cut in real wages.
The shift to the dollar has been universally condemned by Ecuador's popular sectors. Within three months of announcing the plan, Mahuad was forced to resign by a near-insurrection in April, led by the country's indigenous communities. Protests have continued since, albeit on a lesser scale, against his successor, Gustavo Noboa.
The social impact has even been recognised by officials of the World Bank, which backed dollarisation. According to the bank's Ecuador chief, Augusto de la Torre, since the adoption of the dollar, "the economic system has become more corrupt, more politicised and therefore there is more room for the traditional oligarchy to come back, with force".
Western bankers, such as Federico Kaune, the vice-president for "emerging markets at the US investment bank Goldman Sachs, now advise Ecuador that dollarisation will only work if a "fiscal adjustment" is carried out, including a hike in the rate of value-added tax and the privatisation of state assets.
While less extreme, Argentina's hard peg policy has had a similar impact. Since the country went into recession in 1999, however, its government had no monetary or fiscal policy tools with which to stimulate the economy. Even worse, the US Federal Reserve's two-year-long stream of interest rates rises, conducted in an effort to slow the US economy, forced similar rises in Argentinian rates, just the opposite of what was needed.
The worsening recession in turn put pressure on the government's ability to continue to finance its $120 billion foreign debt — and forced a $39.7 billion IMF-led rescue package aimed at placating the Western banks which hold Argentinian debt. The package, approved by the IMF board on January 12, guarantees repayments to those banks due them this year.
The deal in turn mandates lower government spending and a slew of austerity measures, including a freeze in funding to the country's impoverished provinces, a drastic overhaul of the country's health insurance and social security systems, further cuts in public sector workers' real wages and tax breaks for businesses and the wealthy, again all aimed at placating the big Western investors.
Argentinian unions have already held one general strike against the IMF plan, on November 23-24, and another is planned for early March.
Rather than this appalling "choice" between two different forms of dependence, Salvadoran leftists, Ecuadorian indigenous communities and Argentinian unionists have put forward a better idea — get rid of the neo-liberal model altogether, with its surrender to the interests of capital, and strike out on a different path.