Posts Tagged ‘Dollarization’

Dollarization in Foreign Economies

Tuesday, February 10th, 2009

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dollarizationThe term “Dollarization” is when the inhabitants of a country use foreign currency along with (or in place of) their own domestic currency.  Dollarization is not only applied to usage of the United States Dollar, but generally to the use of any other country’s foreign currency as the accepted currency.  Some other currencies that are widely accepted outside of their issuing country of origin are:  the Euro, the South African Rand, the Russian Ruble, and both the New Zealand and Australian Dollars.  For today, however, we’ll focus primarily on the United States Dollar.

Dollarization has never really received much attention, due to the fact that it was generally believed to be politically impossible until 1999, when Jamil Mahuad (then President of Ecuador) attempted official Dollarization through economic reforms of Ecuador’s economy.  He declared a freeze on the country’s bank accounts, in an attempt to control inflation.  This economic plan ultimately lead to a military coup and Mahuad was ousted from office.

Since that time, there have been several other countries that have considered and implemented it as that country’s official policy.  El Salvador, for example, officially adopted the United States dollar in 2001.

Dollarization can fall into three basic categories:

1.  Official Dollarization:  The dollar is the only legal tender, officially adopted, and there is no local currency.  Some examples of countries where this has happened are:  Panama, El Salvador, and Ecuador.  Since their independence in 1903, for example, Panama has used only the United States Dollar exclusively.

This reduces the foreign country’s economic risk, providing a secure, stable economic environment.  These generally tend to be “developing” countries, with transitional economies, especially those with high inflation.

Amazingly enough, the United States Government does not have to provide approval to allow for another country to use its currency as legal tender.

2.  Unofficial Dollarization:  This occurs when private agents, generally in private transactions, prefer the foreign currency over the domestic currency. They might hold, for example, deposits in the foreign currency because of a bad track record of the local currency.  The practice might be widely accepted in that country, but is not classified as “legal tender” by the country’s government.

This can sometimes occur in countries where the United States Dollar has become more prevalent in circulation than the country’s own local currency.  This can be difficult to reverse.

3.  Semi-Dollarization:  Also known as a “Bimonetary System”, foreign currency is legal tender, but plays a role secondary to domestic currency.  Both the United States Dollar and the country’s own currency are used interchangeably.  Cambodia and Lebanon are two countries that practice this, for example.

There are both advantages and disadvantages to Dollarization for a country.

The advantages would be:  Fiscal discipline, resulting in lower inflation and financial stability.  This results in business being easier to conduct within that country, due to the resulting “peace of mind“.  The United States Dollar, for example, has never been devalued, nor has the United States’ notes ever been invalidated.  For a country that has had a past history of bank failures, devaluation and inflation, the temptation of adopting the United States Dollar is strong.

Some disadvantages would be:  Loss of control by the local government, as they lose power and control over inflation and fiscal policy.

It has been estimated that approximately 40-60% of existing United States currency circulates outside of the U.S.  This estimate has been further reinforced by the actions of the U.S. Government, which produced posters and pamphlets between 2003 and 2006, outlining the new look and anti-counterfeiting features of the “New” United States bills in an ASTOUNDING 24 LANGUAGES!

So, the next time you travel outside of the United States and encounter U.S. Currency, or even the next time you pull a Dollar out of your wallet, beaten and worn, looking like it has been “Around the World”, ask yourself:  Where has it been, What countries it has seen,  and how many different hands it has been exchanged through?

To find out where YOUR dollar has been, please visit our FREE Online Dollar Tracking System by clicking on “Enter a Dollar Bill” on the menu above!

Dollarization

Wednesday, September 24th, 2008

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dollarizationDollarization, in a nutshell, transpires when a nation uses foreign currency to substitute theirs. Although the terminology may have different interpretations, officially what happens is a country ceases the use of their own domestic currency and opts for a much stabile foreign currency, usually to help aid their already ailing economies. Although similar in effect, dollarization is another slow but sure-fix alternative to pegging or maintaining a floating currency, which are all efficient methods in endowing a much steady and secure economic and investment environment.

So far, currencies that have been officially used for dollarization are the United States dollar, the Euro, the Australian dollar, the Russian ruble, the Swiss franc, the Indian rupee, the New Zealand dollar, and the Turkish new lira.

Today, more countries in the world have dollarized their currencies to the US dollar as compared to any other foreign money. Amongst some of the countries that have adopted the US dollar as legal tender are British Virgin Islands, East Timor, Marshall Islands, Ecuador, Federated States of Micronesia, El Salvador, Turks and Caicos Islands, Palau, and Panama. These countries may have opted for dollarization due to its emerging and transitional economies, or could also have had owing issues with rising inflation.

Dollarization wasn’t always an approachable option though, as it was previously believed to be not viable on a political stand point. However this changed in 1999, when it began gaining a reputation as an implementable strategy by a number of countries in dire need of an economic surge. This was probably because it was thought to be the most instrumental strategy in lowering inflation and promoting better financial strength.

Many of these countries may have also already been using US dollar informally in prior to fully engaging in dollarization, probably in private or public transactions, banks accounts or even contracts. The full switch to foreign legal tender would mean that individuals and institutions were beginning to desperately protect their interests against an imminent and fore-seeable devaluation of their local exchange rate. Dollarizing their economies would also mean that their financial markets become more credible, ending any further damaging financial speculations and further stifling capital markets. The fact that the disparities in exchange rate is no longer a threat is also a driving factor behind the reduction of interests on foreign lending.

Apart from many of its advantages, dollarization also has its short-comings. One of the main disadvantages of dollarization is a nation virtually gives up its right to directly control its own economy or administer any monetary policies, and its ability to manage exchange rates. This is primarily because with dollarization the country no longer prints its own currency.

Another drawback to dollarization is the practicing country will no longer be able to collect any profits from the issuing of currency. This happens when the cost of producing the currency is lower than the actual currency itself. The US Federal Reserve collects all profits in this instance. Apart from the negative impact this has on GDP, the country in its entirety also suffers a significant loss of income.

Dollarization also robs a nation of its sense of individualism, due to the autonomous financial and economic policy that’s conditioned with it. Whatever the pros and cons of dollarization may be, experts say that it is only to be used as an extreme alternative, as most countries that have adopted it finds it a process that is almost impossible to reverse, without causing long lasting financial repercussions that is.