Official dollarization occurs mostly in small or developing countries. Countries that normally adopt such a radical change in monetary policy are often encountering instable economies, high levels of inflation and a very low competitive currency. Under official dollarization the local currency is completely replaced by the dollar, with the possible exception of coinage. That means domestic banks only accept dollar checking accounts and issue dollar loans. Federal Reserve notes are legal tender and the only form of paper money recognized by the government.
In the case of Semi-dollarization, as in Latin America and in the former Soviet Union, where the purchasing power of the local currency has been volatile and people put more confidence on foreign currency, people often hold dollars as a store of value. In those cases the domestic currency is commonly used in small transactions, but the dollar is preferred in large transactions and in savings.
It should be noticed that although many people associate dollarization with the U.S. dollar, the association is not exclusive. Dollarization may increasingly refer to conversion to other currencies such as the Euro. Besides, South African rand, Russian ruble, New Zealand dollar and Australian dollar are also accepted outside their countries, although in a localized nature. For example, the Russian ruble is accepted in a number of the countries from the old Soviet Union. Thus dollarization may not solely refer to US Dollar. Despite this, in this MC as well as IRP, I will exclusively talk about US Dollar to link it with the reality of
dollarization in Cambodia. Dollarization, in this sense, is different from monetary union because the US continues to set monetary policy in its own interest alone, whereas the European Central Bank is required to take all Eurozone countries’ interests into account.
Origin of Dollarization in World Trade
The origin of dollarization rooted back to the Bretton Woods Agreement. In the aftermath of World War II, US dollar was the only major currency in which international exchange could freely take place thanks to its relatively stable value while all other European’s big economies were shattered due to the war. The dollar's role was formalized under the 1944 Bretton Woods monetary agreement, an international agreement to govern monetary policy among nations. Other nations set official exchange rates against the dollar, while the US agreed to exchange dollars for gold at a fixed price on demand by c
