NCPA - National Center for Policy Analysis

Official and Unofficial Dollarization

April 3, 2000

Dollarization occurs when residents of a country extensively use a foreign currency alongside or instead of the domestic currency. Typically, the U.S. dollar serves as the substitute currency, but "dollarization" can refer the use of the German mark, Japanese yen, or the new European euro in other countries.

Dollarization has three main varieties:

  • Unofficial dollarization occurs when people hold much of their financial wealth in foreign assets even though foreign currency is not legal tender -- such as in most of Latin America and the former Soviet Union.
  • Semiofficial dollarization consist of a bimonetary system where both the national currency and foreign currency are accepted as legal tender -- such as in the Bahamas, Cambodia and the Balkans.
  • Official -- or full -- dollarization means that foreign currency has exclusive or predominant status as full legal tender -- as in Panama, which bases its currency on the U.S. dollar.

People have historically used foreign currency in transactions in their own countries or as "asset substitutions" to protect against domestic inflation. The U.S. permitted use of foreign coins as legal tender until 1857. Currently, the U.S. dollar serves as the world's currency, and the Federal Reserve System estimates that foreigners hold 55 percent to 70 percent of U.S. dollar notes, primarily in $100 bills.

Despite its long history, dollarization is little understood, according to a congressional Joint Economic Committee report. Efforts to dollarize the economy of Argentina early last year, and Ecuador this year, sparked political turmoil and raised the profile of the issue in the U.S. Ecuador already is unofficially dollarized: more than 80 percent of financial assets are in dollars.

Source: Joint Economic Committee Staff Reports, "Basics of Dollarization (Updated January 2000)" and "Ecuador Update: A Note On Ecuador's Dollarization Plan," February 2000.

 

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