The U.S. dollar is recognized as a currency in other countries, and as an official currency within territories like Puerto Rico and Samoa. However, the reach of the U.S dollar extends outside of the United States and its recognized territories, through a process called dollarization. Learn about dollarization, its pros and cons, and which countries use the United States Dollar (USD).
Dollarization basics
Dollarization is the process of adopting the U.S dollar, or another foreign currency, to supplement the domestic currency or to be used as the other country’s official currency.
Dollarization can happen informally, where businesses and people choose to conduct transactions with USD or foreign currency, and it can also be formally adopted by a country. The value of the currency is subject to its respective country. A country could still use the domestic currency, and the USD would be used as a supplementary currency. This is referred to as partial dollarization or currency substation. It can also be done through the de facto market process in full dollarization or currency substitution. In either case, the U.S dollar becomes a medium of exchange used in a country.
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Which countries use USD?
USD is used within the United States and its official territories (Puerto Rico, Guam, America Samoa, U.S. Virgin Islands, and Northern Marina Islands). There are also eleven other countries which use the USD as their official currency. They include:
- Ecuador
- El Salvador
- Zimbabwe
- Palau
- Marshall Islands
- Panama
- The British Virgin Islands
- Turks and Caicos
- Timor and Leste
- Micronesia
- Bonaire
Why do countries undergo dollarization?
Under the world’s current monetary system, a country can decrease and increase their money supply. A country navigating poor economic conditions (or one that has poor monetary policies) may print more money. An oversupply of money can lead to inflation, and inflation is one of the primary reasons why a country may introduce dollarization. Countries with unstable exchange rates or currencies are more susceptible to speculative attacks, which can drastically devalue the worth of the domestic currency. By choosing to introduce a foreign currency, a country can also reduce potential currency devaluation.
Advantages of dollarization
In addition to protecting against inflation and promoting stability, there are other advantages to dollarization:
- Prevent speculative attacks on domestic currency. By using a foreign currency, countries are less susceptible to speculative attacks on the value of their domestic currencies. A speculative attack happens when there is a massive selling of a nation’s currency, which results in immediate and drastic devaluation.
- Improve global economy. The introduction of the USD into a country can help integrate their economy enter the world market. Since it’s widely accepted and stable, some countries may be able to participate more in international trade.
- Faster development. Dollarization promotes economic stability. Investors may feel more secure investing in a country’s economy, and it can spur investment.
Disadvantages of dollarization
Some disadvantages of dollarization are:
- Loss of seigniorage. When a country undergoes dollarization, it first reduces the domestic currency in market by buying it back. Seigniorage, or the profit a government makes issuing its currency, funds this activity. After a country undergoes dollarization, it loses its ability to print money and any future seigniorage.
- Loss of monetary autonomy. When a country dollarizes, they lose control of their money supply, their ability to affect the lending rate, and direct control over the country’s economy.
- Subject to economy of foreign currency. If a country uses a foreign currency for transactions, the value of the currency is subject to its respective country. The economic conditions of the country undergoing US dollarization are affected by the United States’s economy.
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