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January 15, 2001 [WSJ.com -- The Outlook]

The Outlook

MEXICO CITY

The buck stops nowhere. At least that's how it seems in Latin America, as the U.S. dollar is used increasingly to buy groceries, pay employees and sock away savings.

Panama, the first country outside of the U.S. to adopt the dollar as its official currency, did so nearly a century ago, when Uncle Sam built the new nation's waterway. But until recently, it was the exception in a region that stuck by national currencies even as they were devalued and often prompted more embarrassment than pride.

Now, things are changing quickly. On New Year's Day, El Salvador became the third country south of the Rio Grande to abandon its domestic currency in favor of the dollar. Its move came less than a year after Ecuador shocked its neighbors by embracing the dollar as a last-ditch -- and ultimately successful -- move to quell an economic crisis.

Guatemala recently passed a law allowing dollar bank accounts and enabling companies to pay salaries in dollars. Central Bank economist Oscar Monterroso says that isn't a step toward adopting the dollar outright, but most Guatemalans think the move is inevitable. Nicaragua, Honduras and Costa Rica are studying the idea.

"It was a politically taboo subject four years ago, but nowadays everyone is talking about dollarization," says Eduardo Lizano Fait, Costa Rica's central bank president.

Most of Europe's largest countries all but ditched their local currencies two years ago in favor of the euro, which has regained firm footing recently after a slow start. But until now, high-minded talk that the Americas would someday follow in adopting a common currency seemed premature.

What has changed, say economists, is that hot-blooded nationalism is giving way to the more sober argument that common currencies can boost trade and investment, as well as insulate smaller countries from external financial shocks. A recent study by economist Andrew Rose at the University of California, Berkeley, found that trade between two countries sharing a common currency is triple that of comparable countries that maintain their own currencies.

Polls, meantime, indicate that average citizens are open to the idea, too. "Everybody in these countries knows they can easily wake up one morning and find the value of their money gone," says Ricardo Hausmann, former chief economist of the Inter-American Development Bank.

But whether the dollar becomes the euro of the Americas will depend on how Ecuador and El Salvador fare. So far, gambles appear to be paying off. In Ecuador, inflation -- which threatened to spiral out of control 18 months ago -- slowed to a monthly rate of 2.5% in December from 14.3% in January 2000. Interest rates are plummeting and banks are out of intensive care. President Gustavo Noboa described the move as a rabbit pulled from a magician's hat to save the economy from ruin.

El Salvador needed no such rabbit. It has long been a star pupil of Washington's free-trade gospel and enjoyed a steady currency and low inflation. But the country wanted to grow faster and believed that adopting the dollar would eliminate foreign-exchange risk and allow interest rates in the country to fall. That, in turn, would make it possible for businesses to expand faster and would make buying a home affordable for more consumers. Even before the dollar officially made its debut at the start of January, interest rates fell.

If dollarization works in El Salvador and Ecuador, "others will follow," says Mexico's new finance minister, Francisco Gil Diaz, a University of Chicago-trained economist and long a proponent of dollarization.

Of course, some countries may have a harder time adopting the dollar. Brazil, the region's biggest economy, reacts to the idea like it would to the notion of giving up its soccer team. It has good reason: Giving up its currency would be tantamount to turning over monetary policy to Alan Greenspan, who doesn't consider economic conditions in Brazil when deciding whether to raise or lower interest rates in the U.S.

Mexico may be a different case, however. As the U.S.'s second-biggest trading partner, its economy is increasingly tied to its northern neighbor. Mexico's well-respected central bank head, Guillermo Ortiz, who isn't anxious to put himself out of a job, says that the free-floating peso has served Mexico well, and that dollarization is no substitute for keeping a tight hand on the money till.

Still, the idea has its supporters, including Mr. Gil. "It's a discussion that we should keep alive in the next few years," he says.

Were Mexico to eventually dollarize, "then all of Central America will surely follow," says Guillermo Calvo, director of the Center for International Economics at the University of Maryland.

Some doubt whether Latin American governments can ever overcome political reluctance to adopt the ultimate symbol of Yankee imperialism. But if the Germans and French set aside centuries of wars to join their currencies, then anything can happen. Of course, there is one way that the U.S. could make it easier for Latinos to stomach the switch: "Dollar bills are full of dead, white politicians," Mr. Hausmann says. "Why not put some poets on there, or Einstein?"

-- David Luhnow

Write to David Luhnow at david.luhnow@wsj.com



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