Dollarization

Worldwide use of the U.S. dollar and the euro:

  United States

  External adopters of the US dollar

  Currencies pegged to the US dollar

  Currencies pegged to the US dollar within narrow band

  Eurozone

  External adopters of the euro

  Currencies pegged to the euro

  Currencies pegged to the euro within narrow band

Worldwide official use of foreign currency or pegs:

  U.S. dollar users, including the United States

  Currencies pegged to the US dollar

  Euro users, including the Eurozone

  Currencies pegged to the Euro

  Australian dollar users, including Australia

  New Zealand dollar users, including New Zealand

  South African rand users (CMA, including South Africa)

  Indian rupee users and pegs, including India

  Pound sterling users and pegs, including the United Kingdom

  Special Drawing Rights or other currency basket pegs

  Three cases of a country using or pegging the currency of a neighbor

Dollarization occurs when the inhabitants of a country use foreign currency in parallel to or instead of the domestic currency. The term is not only applied to usage of the United States dollar, but generally to the use of any foreign currency as the national currency.

The biggest economies to have officially dollarized as of June 2002 are Panama (since 1904), Ecuador (since 2000), and El Salvador (since 2001). As of August 2005, the United States dollar, the Euro, the New Zealand dollar, the Swiss franc, the Indian rupee, and the Australian dollar were the only currencies used by other countries for official dollarization. In addition, the Armenian dram, Turkish lira, the Israeli shekel, and the Russian ruble are used by internationally unrecognized but de facto independent states.

Origins

After the gold standard was abandoned at the outbreak of World War I and the Bretton Woods Conference following World War II, some countries were desperately seeking ways to promote global economic stability and hence their own prosperity. Countries usually peg their currency to a major convertible currency. When countries choose to use a major convertible currency parallel to or in place of their national currency, this is called the process of dollarization.

Effects

The benefit of dollarization is the elimination of risk of exchange rate fluctuations and possible reduction in the country's international exposure. Though dollarization cannot eliminate the risk of an external crisis, it provides steadier markets as a result of elimination of fluctuations in exchange rates. Dollarized economies can invoke greater confidence among international investors inducing increased investments and growth. Economic integration with the rest of the world becomes easier as a result of lowered transaction costs and greater acceptability of the dollarized currency. It helps promote greater fiscal discipline and thus greater financial stability and lower inflation.

On the other hand, dollarization leads to loss of seigniorage revenue, and a loss of monetary policy autonomy. The country losses the rights to its autonomous monetary and exchange rate policies even in times of financial emergencies.

On banking systems

Commercial banks in countries where saving accounts and loans in foreign currency are allowed may face two types of risks:

1. Currency Mismatch Risk: Assets and liabilities on the balance sheets may be in different denomination. This may arise if the bank converts foreign currency deposits into local currency and lends in local currency or vice versa.
2. Default risk: Arises if the bank uses the foreign currency deposits to lend in foreign currency.

Types

Dollarization can occur in a number of situations. It can be used unofficially, when private agents prefer the foreign currency over the domestic currency. For example, they hold deposits in the foreign currency because of a bad track record of the local currency, or as a hedge against inflation of the domestic currency.

It can be used semiofficially (or officially bimonetary systems), where the foreign currency is legal tender alongside the domestic currency.

Some countries use a foreign currency as the sole legal tender, and have ceased to issue the domestic currency. Another effect of a country adopting a foreign currency as its own is that the country gives up all power to vary its exchange rate, with its economy being pegged to that of the foreign country.

U.S. dollar

Countries using the U.S. dollar exclusively

• British Virgin Islands
• Caribbean Netherlands (from 1 January 2011)
• East Timor (uses its own coins)
• Ecuador (uses its own coins in addition to U.S. coins; Ecuador adopted the U.S. dollar as its legal tender in 2000.
• El Salvador
• Marshall Islands
• Federated States of Micronesia (Micronesia used the U.S. dollar since 1944 )
• Palau (Palau adopted the U.S. dollar since 1944 )
• Panama (uses its own coins in addition to U.S. coins. This country has adopted the U.S. dollar as legal tender since 1904).
• Puerto Rico
• Turks and Caicos Islands

Countries using the U.S. dollar alongside other currencies

• Bahamas
• Nicaragua
• Cambodia (uses Cambodian Riel for many official transactions but most businesses deal exclusively in dollars)
• Lebanon (along with the Lebanese pound)
• Liberia (was fully dollarized until 1982 the year the National Bank of Liberia started to issue five dollar coins  ; U.S. dollar still in common usage alongside Liberian dollar)
• Zimbabwe
• Haiti uses the U.S Dollar alongside its domestic currency called "Gourde"

Euro

Main article: International status and usage of the euro

• Andorra (formerly French franc and Spanish peseta since 1278 )
• Kosovo
• Monaco (formerly French franc since 1865 ; issues its own euro coins)
• Montenegro (formerly German mark and Yugoslav dinar)
• San Marino (formerly Italian lira; issues its own euro coins)
• Vatican City (formerly Italian lira; issues its own euro coins)

New Zealand dollar

• Cook Islands (issues its own coins and some notes)
• Niue
• Pitcairn Island
• Tokelau

Australian dollar

• Kiribati (issues its own coins; Kiribati has used the Australian dollar since 1943 )
• Nauru(was fully dollarized since 1914 ).
• Tuvalu (issues its own coins; Tuvalu has used the Australian dollar alongside its domestic currency since 1892 )

South African rand

Further information: Common Monetary Area

• Lesotho
• Namibia
• Swaziland

Zimbabwe

Due to the hyperinflation and official abandonment of the Zimbabwean dollar several currencies are used instead:

• British Pound Sterling
• Botswana pula
• Euro
• South African rand
• United States dollar

The U.S. dollar has been officially adopted for all transactions involving the new power-sharing government.

Others

• Armenian dram: Nagorno-Karabakh Republic
• Russian ruble: Abkhazia and South Ossetia (de facto independent states, but recognized as part of Georgia by nearly all other states)
• Indian rupee: Bhutan and Nepal
• Swiss franc: Liechtenstein
• Israeli shekel: Palestinian territories
• Turkish lira: Turkish Republic of Northern Cyprus (de facto independent state, but recognized as part of Cyprus by all states but Turkey)

See also

• Monetary union
• Currency board
• Domestic Liability Dollarization

External links

• Dollarization.org (Reference for list of dollarized economies)