Parallel Currencies and Dollarized Nations

When we visited Maldives a couple of years ago, we realized the US dollar is accepted as legal tender everywhere. Even though the country has its own currency, the Maldivian Rufiyaa. In her book, The Almighty Dollar, Dharshini David says there’s a name for this: “parallel currency”.

 

One can see why tiny, tourist’y nations like Maldives would accept the dollar (it saves tourists the hassle and costs of conversions). Or why a country like Panama (think of all the fees in the Panama Canal) would do the same. But the dollar is also the parallel currency in countries where the local folks have no faith in their economy and/or government. Like Russia when the USSR collapsed. The same reason applies in several Latin American countries and Cambodia even today. Of course, a parallel currency also makes corruption and black money even more easy: transactions in the parallel currency never show up in the country’s financial systems.

 

And then there are countries that have eliminated their own currencies and replaced it officially with the US dollar! Like Ecuador and El Salvador. Why would countries “dollarize”? For one, if their trade is overwhelmingly with the US, you can see the benefits of avoiding all those conversion costs and fluctuating exchange rates. Another reason is that it inspires confidence in foreign investors: they don’t have to worry about the currency being devalued.

 

But of course, “dollarizing” comes at a cost. Those countries can’t print money, should the need arise. If you don’t see why that’s a problem, just look back at the problems the PIGS (Portugal, Italy, Greece and Spain) ran into during the 2008 financial crisis. They couldn’t deploy the usual tool in such crisis: printing money. Why not? Because the Euro wasn’t their currency alone. The Germans refused, and the PIGS were stuck…

 

In addition, a country that has its own currency can raise and reduce interest rates based on its needs. Not so if you are dollarized: the US government sets the rates based on what’s good for the US, and you’d have no say in it.

 

And finally, American law allows the US to prosecute any transaction anywhere in the world that “touches” the US. By definition, the dollar, no matter where it is used in the world, “touches” the US since that is where it originated. And so, any corruption involving use of the dollar, technically, entitles the US to prosecute! Remember the FIFA corruption scandal a few years back? I’d always wondered why the prosecution for that originated in the US, a country that doesn’t even care about football. The answer from this book? Because most of the kickbacks were in dollars…

 

The book doesn’t talk of it, but I wonder what happens to all the dollars outside the US (and half of all those dollars are outside the US at any point) ever “demonetizes” old notes, say, ones without certain anti-forgery features?

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