Dollarization

Dollarization is the process by which a country adopts a foreign currency—most commonly the U.S. dollar—as a medium of exchange or legal tender alongside or instead of its domestic currency. It often emerges in response to severe inflation or chronic economic instability that erodes confidence in the local currency.

Key takeaways

• Dollarization replaces or supplements a national currency with a foreign one, typically the U.S. dollar.
• It can stabilize prices and restore confidence, but it requires surrendering independent monetary policy.
• Benefits are greater in small, trade-linked economies; costs include lost seigniorage and reduced policy flexibility.

How dollarization occurs

• De jure (official): the government legally designates a foreign currency as legal tender.
• De facto (market-driven): households and businesses prefer a foreign currency for transactions and savings even without formal adoption.

Governments or markets turn to dollarization to gain price stability and reduce exchange-rate risk. However, by adopting another country’s currency, the dollarizing nation effectively outsources monetary policy decisions to the currency issuer (e.g., the U.S. Federal Reserve), which sets policy according to its own national objectives.

Benefits

• Rapid reduction of inflation and volatility when a stable currency replaces a failing one.
• Greater predictability for prices and contracts, which can encourage investment and trade.
• Saves resources needed to operate an independent monetary system and can be advantageous for small economies with strong trade ties to the currency issuer.

Costs and pitfalls

• Loss of monetary sovereignty—no independent control over interest rates or money supply.
• Forfeiture of seigniorage (profits from issuing currency).
• Central bank cannot act as lender of last resort in the same way, which may weaken financial safety nets.
• Limits ability to devalue the currency to boost competitiveness.
• Regulatory and institutional mismatches with the currency issuer can complicate financial integration and deter some investors.

Example: Zimbabwe

Zimbabwe provides a prominent recent case:
* Hyperinflation peaked in 2008, prompting widespread use of the U.S. dollar.
* The U.S. dollar became legal tender and was widely used after 2009, stabilizing inflation and improving purchasing power and investment conditions.
* Drawbacks included loss of monetary control and challenges for banking regulation and competitiveness.
* The government later pursued de-dollarization: banning foreign currencies in 2019 with the introduction of the RTGS dollar, and rolling out a new currency, the Zimbabwe Gold (ZiG), in 2024 to rebuild local-currency confidence.

De-dollarization

De-dollarization is the reverse process—efforts to reduce reliance on foreign currency and reestablish a national currency—typically undertaken once macroeconomic stability and institutional credibility improve.

Impact on the issuing country (e.g., the U.S.)

Widespread use of the U.S. dollar abroad tends to strengthen global confidence in the dollar and can generate additional seigniorage revenue for the issuing country. It also reinforces the dollar’s role in international trade and finance.

Bottom line

Dollarization can be an effective crisis-management tool to curb hyperinflation and restore stability. It brings tangible benefits in terms of price stability and reduced exchange-rate risk, but at the cost of monetary autonomy and related policy tools. Countries considering dollarization must weigh short-term stabilization gains against long-term strategic losses in economic sovereignty.