Definition of DollarizationDollarization occurs when one country adopts a more stable foreign currency to use alongside or instead of its domestic currency. This often occurs in developing countries, newly independent countries, or in countries transitioning to a market economy. Dollarization also often occurs in territories, dependencies, and other non-independent places. Unofficial dollarization occurs when only some purchases and assets are made or held in the foreign currency. The domestic currency is still printed and accepted. Official dollarization occurs when a foreign currency is the exclusive legal tender, and all wages, sales, loans, debts, taxes, and assets are paid or held in the foreign currency. Dollarization is nearly irreversible. Many countries have considered full dollarization but decided against it due to its permanency.
The Benefits of DollarizationMany advantages occur when a country adopts a foreign currency. The new currency helps stabilize the economy, which sometimes eases political crises. This credibility and predictability promotes foreign investment. The new currency helps lower inflation and interest rates and eliminates conversion fees and the risk of devaluation.
Disadvantages of DollarizationIf a country adopts a foreign currency, the national central bank no longer exists. The country can no longer control its own monetary policy or aid the economy in case of emergency. It can no longer collect seigniorage, which is a profit gained because the cost to produce money is usually less than its value. Under dollarization, seigniorage is earned by the foreign country. Many believe that dollarization symbolizes foreign control and causes dependency. National currencies are a source of great pride for citizens, and some are very reluctant to give up the symbol of their country's sovereignty. Dollarization does not solve all economic or political problems, and countries can still default on debt or maintain low living standards.
Dollarized Countries That Use the United States DollarPanama decided to adopt the United States dollar as its currency in 1904. Since then, Panama's economy has been one of the most successful in Latin America.
In the late 20th century, Ecuador's economy declined rapidly due to natural disasters and lower global demand for petroleum. Inflation soared, the Ecuadorian sucre lost much of its value, and Ecuador could not repay foreign debt. In the midst of political turmoil, Ecuador dollarized its economy in 2000, and the economy has since slowly improved.
El Salvador dollarized its economy in 2001. Much trade occurs between the United States and El Salvador. Many Salvadorians go to the United States to work and send money home to their families.
East Timor gained independence in 2002 after a long struggle with Indonesia. East Timor adopted the United States dollar as its currency in the hope that monetary aid and investment would more easily enter this poor country.
The Pacific Ocean countries of Palau, the Marshall Islands, and the Federated States of Micronesia use the United States dollar as their currencies. These countries gained independence from the United States in the 1980s and 1990s.
Zimbabwe has experienced some of the world's worst inflation. In 2009, the Zimbabwean government abandoned the Zimbabwean dollar and declared that the United States Dollar, South African rand, British pound sterling, and Botswana's pula would be accepted as legal tender. The Zimbabwean dollar may one day be revived.
Dollarized Countries That Use Other Currencies than the United States DollarThe three small Pacific Ocean countries of Kiribati, Tuvalu, and Nauru use the Australian dollar as their currency.
The South African rand is used in Namibia, Swaziland, and Lesotho, alongside their official currencies of the Namibian Dollar, lilangeni, and loti, respectively.
The Indian Rupee is used in Bhutan and Nepal, alongside the Bhutanese ngultrum and the Nepalese rupee, respectively.
Liechtenstein has used the Swiss franc as its currency since 1920.
Currency UnionsAnother type of currency integration is a currency union. A currency union is a group of countries that have decided to use a single currency. Currency unions eliminate the need to exchange money while traveling in other member countries. Business among member countries is more frequent and easier to calculate. The most well-known currency union is the euro. Numerous European countries now use the euro, which was first introduced in 1999.
Another currency union is the East Caribbean Dollar. 625,000 residents of six countries and two British territories use the East Caribbean dollar. It was first introduced in 1965.
The CFA Franc is the common currency of fourteen African countries. In the 1940s, France created the currency to improve the economies of some of its African colonies. Today, over 100 million people use the Central and West African CFA Francs. The CFA Franc, which is guaranteed by the French treasury and has a fixed exchange rate to the euro, has helped stabilize the economies of these developing countries by promoting trade and reducing inflation. The profitable, abundant natural resources of these African countries are more easily exported. (See page two for a listing of countries using the East Caribbean Dollar, West African CFA Franc, and Central African CFA Franc.)