Dollarization

Dollarization occurs when a country consciously adopts United States dollar as its preferred currency.

The US dollar can be used in isolation or form a parallel coinage with local currency.

Forms of Dollarization

Full dollarization is generally implemented by countries at the transitional economic growth phase- especially those suffering from high inflation. Dollarization may, however, occur in various forms:

• It may occur at an official level when a nation stops using local currency and utilizes only US dollars as the national currency
• Dollarization may exist in a semi-official form.US dollar is used in local currency transactions- but plays a secondary role to local currency.
• Unofficial dollarization may occur without approval from local government.

It is to be noted that the term ‘dollarization’ may include any foreign currency- and not restricted to the United States dollar only. While the US dollar is used as local currency in countries like Ecuador, Marshall Islands and Panama, Euro currency is used as legal tender in Vatican City, Andorra and Monaco.

Advantages

Dollarization of a foreign country has both advantages and disadvantages.

The advantages of full dollarization include:

• Full dollarization decreases the nation’s risk of currency devaluation and inflation.
• Investor confidence in that country increases. A more stable capital market develops.
• Almost hassle-free balance of payments.
• Smoother integration of that country’s economy with global economies.

Disadvantages

The disadvantages of dollarization include:

• The nation loses the right to control its own monetary policy
• Country’s central bank loses its power to accumulate seigniorage. Seigniorage is profit accrued from coinage issue. United States Federal Reserve, in turn, garners seigniorage and local government is forced to forgo an income. Country’s Gross Domestic Product (GDP) suffers as a result.
• The central bank of that country forgoes its right as a lender of last resort for its financial network.
• A nation must possess substantial foreign currency reserves to maintain a current account surplus

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