Magazine article USA TODAY

Dispelling Monetary Doldrums Via Dollarization

Magazine article USA TODAY

Dispelling Monetary Doldrums Via Dollarization

Article excerpt

THE RULE OF LAW subjects the state to a fixed set of rules that limits the scope of its coercive powers. Individuals and their property are protected from the arbitrary, ad hoc actions of the state and other individuals. In consequence, individuals can plan their activities within the confines of known, fixed "rules of the game." This allows people to pursue their personal ends, as long as their actions do not infringe on the broadly-defined property rights of their fellow citizens. When properly applied, the rule of law guarantees freedoms in the economic, political, intellectual, and moral spheres. In the economic sphere, money constitutes an important element.

Austrian economist Ludwig von Mises dealt at length with this issue in The Theory of Money and Credit (1912): "It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights. The demand for constitutional guarantees and for bills of rights was a reaction against arbitrary rule and the nonobservance of old customs by kings. The postulate of sound money was first brought up as a response to the princely practice of debasing the coinage. It was later carefully elaborated and perfected in he age which--through the experience of the American Continental Currency, the paper money of the French Revolution, and the British Restriction period--had learned what a government can do to a nation's currency system."

Today, Venezuela has, at best, a tenuous grip on the rule of law. This is nowhere more visible than in the monetary sphere. The country's foreign exchange reserves are falling like a stone. Relative to the U.S. dollar, Venezuela's currency, the bolivar, also is dropping precipitously, losing 47% against the greenback just since the start of the year.

As night follows day, inflation has soared as the bolivar has plunged. I estimate Venezuela's annual inflation rate at 335%--the highest in the world. For those holding bolivars, it amounts to no rule of law and bad money. It is worth noting that currency debasement and inflation robbery were not always the order of the day in Caracas. During the 1950s, the average annual inflation rate was 1.7%, not much above Switzerland's. In the 1960s, inflation in Venezuela fell to a 1.2%. It was not until the 1980s that Venezuela experienced a decade of double-digit annual inflation. Today, inflation, contrary to the official numbers and amateur estimates, has soared well into triple-digit territory.

Facing this inflationary theft, Venezuelans have voted with their wallets. Indeed, they unofficially have begun to dollarize the economy. However, the only way to establish the rule of law in the monetary sphere is to dollarize the economy officially by dumping the hapless bolivar and replacing it with the U.S. dollar. Ecuador, where I served as the chief advisor to the Minister of Finance, when that country dollarized, offers some lessons that merit Caracas' attention.

Ecuador represents a prime example of a country that was incapable of imposing the rule of law and safeguarding the value of its currency, the sucre. The Banco Central del Ecuador was established in 1927, with a sucre-U.S. dollar exchange rate of five. Until the 1980s, the central bank periodically devalued the sucre against the dollar, violating the rule of law. …

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