Dolarization

Dollarization becomes a hot topic and importance, after Latin American countries adopted this scheme, due to the distrust that has on its currency. A broad concept of dollarization refers to any process where foreign money replaces the domestic money in any of its functions. Indeed, dollarization of an economy is a special case of substitution of local currency for the dollar as a store ofvalue, unit of account and a means of payment and exchange.

The process may have different origins; one is the supply side, which means the autonomous and sovereign decision of a nation that meets genuine currency used as the dollar (Panama). Another possible origin for the demand side, it is as a result of portfolio decisions of individuals and businesses that happen to use the dollar as currency,to perceive it as a refuge from the loss of value of the domestic currency in scenarios of high price instability and exchange rate. The use of the dollar drift, in the latter case, the preventive behavior of the sum of individuals rationally choose to preserve the value of keeping their wealth in dollars and thus sheltering the devastating effect of devaluations and high inflation. Whendollarization is a process derived from decisions of individuals is very difficult to think of their reversal.

We can distinguish two dollarization processes on the side of demand: currency substitution and asset substitution. Currency substitution, which refers to transaction motives, occurs when foreign currency is used as means of payment; in this sense, the agents fail to use the national currencyfor their transactions. Replacement of assets, which makes relative to the function of money as a store of value, risk and return considerations, occurs when assets denominated in foreign currencies are used as part of an investment portfolio.

Among the factors that explain the phenomena of dollarization, especially in Latin America, and have played an important role in the process are:macroeconomic instability, underdeveloped financial markets, lack of credibility in stabilization programs, the globalization of the economy, the history of high inflation, institutional factors, among others.
Dollarization processes arise in a country as a result of loss of confidence in the traditional roles of the local currency. Adopt a policy of full dollarization of an economy involvesreplacement of 100% of the local currency for foreign currency, which means that prices, wages and contracts are set in dollars.

Full dollarization rests on some specific principles:

• The single currency is the dollar and the local currency disappears. In the case of Ecuador it is contemplated that the local currency circulates only as coins.
• The money supply becomes denominated in dollars andfeeds the balance of the balance of payments and a sufficient initial amount of international reserves.
• Capitals are free to come and go without restrictions.
• The Central Bank restructures its traditional functions and acquire new functions.

The formal dollarization generally involves the almost immediate recovery of credibility, and is expected to end with the origin of distrust:inflation and recurrent devaluations. Also, the formal or official dollarization requires rulers to discipline and reveals the structural problems of the economy, which encourages companies to change their structures.

Among the advantages that can be seen from the formal dollarization include the following:

• The effects of external shocks is particularized
The loss in terms of trade,disasters that affect export production, the imposition of quotes, tariffs and taxes on the products you sell the country to the world, among others, are called external shocks. Official dollarization ensures particularization of these shocks exclusively in the sector concerned; it eliminates the possibility of currency devaluation.



• Converge the local inflation rate with the United States
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