(Photo: Noor Khamis/Reuters)

Ecuador Announces World's First Digital Currency

Will it expand opportunity for the poor? Or just allow the government to manipulate the economy for its own benefit? Economists disagree.
Sep 8, 2014· 3 MIN READ
Paul Tullis is TakePart's Features Editor, and a Contributing Writer for The New York Times Magazine.

Last month I flew six and a half hours from Los Angeles, changed planes, flew another two hours, went through customs, and kept using the dollars I’d brought with me. Had I landed in Guam? Was I participating in some underground economy overseas?

No, I’d gone to Ecuador.

Like Panama, El Salvador, and a handful of tiny nations in the Caribbean and South Pacific, Ecuador adopted the U.S. dollar as its official currency back in 2000. As of December, the government just announced, the dollar will have a companion in the South American country: an as-yet-unnamed currency that will exist purely in digital form, stored largely on users’ cell phones. Quito is trumpeting its move as enabling safe storage and transaction of money for people locked out of the bank-based economy, increasing opportunity for the poor. But some economists say the new currency could be the beginning of the end of a decade of stability and wealth expansion in Ecuador that dollarization ushered in.

The switch from the old currency occurred following a period of financial chaos, during which the value of the sucre fluctuated widely. That made it difficult for individuals and businesses to plan and invest, said Steve Hanke, professor of applied economics at Johns Hopkins University, who was chief adviser to Ecuador’s minister of finance during the transition. It was “like having a yardstick that’s changing length all the time,” he said.

Since the switch, per capita income in Ecuador has nearly quadrupled, to $5,720—despite government policies that Hanke characterized as “anti-growth.” He said that’s because with the United States’ currency, Ecuador also got the dollar’s inflation rate and its exchange rate against other currencies. The three Latin American countries using dollars today have the lowest “misery index”—that’s the sum of the inflation, unemployment, and bank lending rates less the GDP growth—in the region.

Now Ecuador is breaking new ground in finance: If all goes according to plan, in December it will become the first country in the world with a national digital currency, existing for the foreseeable future alongside the dollar. No bills, no coins, no ATMs, no losing money in the dryer—this money will exist only virtually, mainly on users’ cell phones.

The new currency will be significantly different from the M-Pesa mobile payment system, which has been hugely popular in East Africa and most other places where it’s available. There, local citizens are storing local currency on their phones and moving it around electronically. The effect, according to economists at MIT and Georgetown who studied it, has been to increase users’ savings and reduce barriers to commerce by facilitating transactions. Users love M-Pesa, and it’s demonstrably making the poor less so: Those with accounts have higher savings rates than nonusers and report less savings lost.

Apparently seeking to hitch the new digital currency to M-Pesa’s wagon, Ecuador’s National Assembly cited increased participation and economic growth, in a statement, as reasons it OK’d the currency. But some economists said the government might have other motives.

While people will be able to exchange the new currency for dollars one-to-one, according to the government, the e-money will be issued by the Central Bank of Ecuador. That may not seem like much of a difference compared with M-Pesa’s electronic storing of local currency, but the importance for Ecuador’s government is huge. Marc Weisbrot of the Center for Economic and Policy Research said that Ecuador’s exclusive use of the dollar “eliminates the ability to use the exchange rate as a tool of policy, and it severely restricts monetary policy as well.” That makes the government less flexible in its ability to manipulate the economy—which, Hanke said, was a good thing given the corruption, incompetence, and political gamesmanship that existed in Ecuador in the 1990s.

But if millions or billions of dollars’ worth of the new currency is circulating, the government can use it instead of U.S. dollars to pay its bills. Once the money is out there, the government can change the exchange rate against the dollar—the same kind of shenanigans that led to the chaos Ecuador was trying to escape when it adopted the dollar in 2000.

“The fear,” said Hanke, “is that [the new currency] will undermine the dollarized system—it will contaminate it and confuse things. The government might be able to force suppliers to take this stuff at par [with the dollar], but it'll sell on a secondary market at a big discount.” That would effectively lower its value against the dollar, wiping out some of the benefit to the users the government says it’s trying to help.

“My guess,” Hanke continued, “is it'll end up failing and cause a lot of chaos and trouble in a system that's doing well.”

He’ll need to keep such ideas to himself; in August Pres. Rafael Correa’s government passed a law making it a crime to "publish, broadcast or spread" any information it deems as having the potential to cause “economic panic.”