How Do You Replace the Sucre With the Dollar?

Ecuador abandoned the sucre for the U.S. dollar last year. El Salvador has ridded itself of its indigenous currency for the greenback, too. How does this process of “dollarization” work?

The purpose of dollarization is simple: Substitute the strong, stable U.S. dollar for a weaker domestic currency. Dollarization insulates a country from economic shocks such as currency devaluation or run-away inflation because the local government can’t inflate the currency by turning on the printing presses (unless, of course, the U.S. economy tanks). The advantage of a stable currency is that it makes economic calculation less risky for business. Where currencies are unstable, long-term fixed-rate mortgages are almost impossible to secure. A switch to the dollar makes such loans possible.

Any country is free to drop its currency and adopt ours–no one has to ask for Alan Greenspan’s permission. But while countries don’t need the Federal Reserve’s approval to dollarize, the United States has made it clear that dollarization will neither give a country a voice in Fed policy, or special status for future bailouts. Having foreigners using dollars abroad is nothing new: It is estimated that between 55 percent to 70 percent of the $480 billion in U.S. paper currency in circulation is circulating outside the United States. When Ecuador made the switch–it did notify the United States of its intention–the country swapped $400 million in U.S. Treasuries and other assets for cash through a Miami bank and had the whole caboodle flown down. (Explainer has a standing offer to take the middle seat and accompany the money in any such future transactions.) Most countries that switch continue to mint their own coins, however. Coins make up less than 10 percent of circulating currency, and shipping costs of U.S. coins are prohibitive.

While Ecuador, El Salvador, Panama (since 1904), Puerto Rico (since 1899), and a few Caribbean and Pacific island nations officially use U.S. currency, many more countries have semi- or unofficial ties to our currency. Argentina, for example, has fixed their peso to equal one dollar, and half the country’s bank deposits are in dollars. Most of Latin America, the former Soviet Union, and even Vietnam have heavily dollar-dependent economies–people often make purchases of big-ticket items like cars in dollars. It is estimated that Russia has more dollars in circulation than rubles.

Next question?

For more on dollarization see thisreport. For why former Slate columnist Paul Krugman thinks dollarization isn’t such a good idea see thiscolumn.