Zimbabwe Dollarized. How Does the U.S. Feel About That?

The rainbow of 20s you get from the ATM in Harare

Here’s a section that got cut from my New Republic story about the use of the US dollar in Zimbabwe

Wait, so a country can just adopt the United States’s currency without our permission?

“The U.S. government has never taken any overt position on dollarization, formal or informal.” This is Benjamin Cohen, a political economy processor at the University of California Santa Barbara, former Fed employee and the author of some articles I’ve been reading to try to understand how one country just gets up one morning and starts using another country’s money.

Ninety percent of the world’s $100 bills, Dr. Cohen says, are in circulation outside of the United States. Dozens of countries are considered  to be “highly dollarized,” meaning more than 30 percent of their money supply is in dollars.

Unlike Zimbabwe, which has formally adopted the dollar, most countries use the U.S. dollar informally, in parallel with the local currency. A few years ago I was in Cambodia for work, and found that the local currency, the riel, was only used for small stuff like meals, transport and entertainment. Anything major—a TV, a plane ticket, an iPhone—prices were quoted and paid in U.S. dollars.

It’s not just Cambodia. These sorts of arrangements are commonplace throughout the Middle East, Latin America and Southeast Asia. People use the local currency, but keep U.S. dollars as a hedge against inflation, like Tea Partiers hoarding gold.

According to Cohen, the United States has no reason to prevent these arrangements. Not only does the U.S. dollar provide a quarry of monetary calm for citizens of inflating nations, the U.S. actually makes money every time our money leaves our borders. “Seniorage,” as the economists call it, is the profit the U.S. earns every time a foreigner ‘buys’ a dollar for a dollar (It costs 6 cents to print a $1 bill. If you print one, then use it to buy something that costs a dollar, you’ve just earned 94 cents profit. That’s seniorage.).

This sounds like it shouldn’t be a real thing, but the US earns $20 billion per year from all those $100 bills held internationally. Not a huge proportion of GDP, but hey, free money, right?

The other upsides are obvious. Every time another country uses our currency, it reinforces the U.S. dollar as world’s preferred international currency, just like every time someone drinks a Coke or eats a Big Mac it reinforces the status of those brands.

Foreign countries using our currency even gives us diplomatic power. Panama, one of the first countries to formally adopt the U.S. dollar, froze in its tracks when the U.S. cut off access to hard currency in the late 1980s to put pressure on Noriega.

The only real downside of foreign countries dollarizing, for the U.S. at least, is that it creates a headache for the Fed. The more countries dollarize, the more the Fed has to take them into account when making monetary policy. A million calculations go into the decision to raise or lower interest rates, and the last thing the Fed needs is to add the interests of Cambodian iPod salesmen into the mix.

One of the more significant downsides is if a dollarized country suddenly reintroduced their domestic currency, it might flood the market with millions of now-unneeded U.S. dollars, reducing the value of all of them. It doesn’t even have to be a whole country. If the dollar was used widely enough, huge purchases of dollars by foreigners could significantly affect its value.

This is why, Cohen says, the U.S. takes a policy of “benign neglect” toward foreign countries that want to formally or informally dollarize. You want to buy a bunch of dollars and give them to your citizens in exchange for your old currency? Fine. You want to encourage your banks to offer accounts denominated in U.S. dollars? Have a blast. The U.S. isn’t going to be particularly helpful in helping you set this up, but they’re not going to stop you either.

Ten countries (East Timor, Ecuador, El Salvador, Panama and a bunch of small island nations) are formally dollarized, meaning the U.S. dollar is their official currency (most of them have their own coins though).

Zimbabwe is formally dollarized in that all government spending is in U.S. dollars, but it also recognizes the euro, the British pound, the Botswanan pula and the South African rand (why the Mozambican metical got left out, I have no idea). Stores accept payment in whatever currency you have handy, and sometimes give you change in a different currency than you paid.

One of the things that always surprised me about Zimbabwe was how it just switched to U.S. dollars one day, without any relationship to the U.S. Federal Reserve. It was even under sanctions at the time. Can it just do that?

“It’s totally normal to switch to the U.S. dollar without any relationship to the Fed,” Cohen says. “It doesn’t require an application. Anyone can buy paper money, and anyone can get a dollar bank account. Their own country may restrict those things, but the U.S. doesn’t.”

When Ecuador officially adopted the U.S. dollar in 2000, it carried out a mass currency conversion. The central bank sold their U.S. treasury bonds to the U.S. for cash, brought the cash back to Ecuador and gave Ecuadoreans a window in which to exchange their sucres for U.S. dollars. The U.S. didn’t orchestrate, nor condemn, this process.

Like an introduced species, the U.S. dollar tends to take over an increasingly large percentage of the economy. The only country Cohen knows of that has de-dollarized is Israel, which introduced the U.S. dollar in the late 1970s as a parallel currency, and only managed to get rid of it after a series of economic reforms reinstated confidence in the shekel. Lots of informally dollarized countries, like Argentina, go through waves of increasing, then decreasing dollarization in line with citizens’ confidence in the local currency.

I have no idea what any of this means for Zimbabwe. As I say in the New Republic story, bringing back the Zimbabwe dollar is seen by economists (including the head of the Reserve Bank of Zimbabwe) as a bad idea, but that doesn’t mean it won’t happen.

Dr. Cohen’s written a bunch of interesting, easy to read articles on dollarization from the US perspective

 Thanks for the interview!

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Filed under Random, Serious, Travel, Work

11 responses to “Zimbabwe Dollarized. How Does the U.S. Feel About That?

  1. Well they will soon regret it..
    as far as I know..


  2. C9

    Whooo! I love that Botswana got mentioned! And even though I was living in Botswana, and have visited Zimbabwe, I didn’t know that they accepted any currency! Maybe because I was a kid. But I remember my parents exchanging the pula and getting tons of Zimbabwe Doallars. o.O

  3. Interesting. I’ve never really read anything about this before.

  4. Thank you for taking the time to paint a true picture of the actrocity that is Zimbabwe. Thank you for your courage.

  5. Helen

    Your article seems to answer the title question – in the short term, this makes a lot of money for the US, and in the long term, it solidifies financial control over the dollarized countries. One of the main goals of all those wars in the ME is to bring the financial structures under the umbrella of the US system and to kill any competing structures – look what happened to Libya when it tried to create a unified African financial organization. What’s not to love?

  6. the dollar is owned by the federal reserve and the federal reserve is as federal as federal express, this institution has never been audited by any government or independent agency ever, they actually loan money to the government with interest hence we pay taxes, of course they will be happy to have other countries use their currency, thats the equivalent of asking if coca cola would be happy to have another country consume their products?

  7. I visited Turkey a few years ago and shopkeepers were quite disgruntled when we tried to pay in lira instead of euro even though lira is the Turkish currency

  8. heh I know this is an old post, but I kept it around as I thought I’d enjoy reading it. I’m glad you mentioned Argentina there at the end—I bought stuff using dollars in Buenos Aires when I was there 2 years ago. And I witnessed an “illegal” transaction where someone sold $100 bills in South Africa for a level below the official exchange rate. Though based on this article, I’m not sure that was illegal after all.

    At any rate, based on what I’ve seen, using dollars instead of local currency seems to put people’s minds at ease, and it certainly doesn’t hurt the U.S. One of those weird win-win situations that resides entirely in a gray area.

  9. If more countries adopt the U.S. dollar as their official currency, then perhaps the Federal Reserve would be held to a higher standard regarding their monetary policy. I would suspect that this move would promote more accountability.

    • Jackson

      More accountability but more of a headache to implement. Next time you criticize the Fed, maybe think about the other nations that their decisions are impacting. You can’t be open to more countries becoming dollarized but then whine that monetary policy doesn’t completely satisfy the U.S. You can’t have it both ways, unfortunately.

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