Dollarization in Foreign Economies
Tuesday, February 10th, 2009
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The 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!
