Dollarization describes a spectrum of arrangements. Unofficial (or de facto) dollarization occurs when residents voluntarily hold foreign currency—usually U.S. dollars—as a hedge against inflation or devaluation, even though the local currency remains legal tender. Official (or full) dollarization occurs when a government formally adopts a foreign currency as legal tender, either replacing or circulating alongside the domestic one. The term is generic: the adopted currency can be the euro, South African rand, Australian dollar, or another anchor.
Governments pursue dollarization to import monetary credibility, lower inflation expectations, reduce exchange-rate risk, and cut borrowing costs. The principal trade-off is the loss of an independent monetary policy and of seigniorage revenue, plus the inability to act as lender of last resort in the anchor currency. Because there is no swap line or formal seat at the issuing central bank (e.g., the U.S. Federal Reserve), dollarized economies are exposed to monetary decisions taken abroad with no domestic input.
Notable cases of official dollarization with the U.S. dollar include Panama (since its independence in 1903, under the 1904 Monetary Agreement), Ecuador (adopted in 2000 under President Jamil Mahuad after the sucre collapsed), El Salvador (Monetary Integration Law, 2001, under President Francisco Flores), Zimbabwe (a multi-currency regime introduced in 2009 after hyperinflation, later modified), and Timor-Leste (since 2000). Kosovo and Montenegro use the euro unilaterally without being eurozone members. In 2023, Argentine presidential candidate Javier Milei campaigned on dollarizing Argentina, though no full adoption followed his election.
Dollarization is distinct from a currency board (which keeps a domestic currency fully backed by foreign reserves, as Hong Kong does) and from a monetary union (where members jointly govern the issuing institution, as in the eurozone). It is also distinct from liability dollarization, where debts—not the unit of account—are denominated in foreign currency, a feature that complicated the 2001–2002 Argentine crisis.
Example
In January 2000, Ecuador abandoned the sucre and adopted the U.S. dollar as legal tender to halt hyperinflation and stabilize the economy after a severe banking crisis.