Шет ел валютасын қолдану және валюта алмасу

Use of a foreign currency in parallel to or instead of a domestic currency

Currency substitution is the use of a foreign currency in parallel to or instead of a domestic currency. Currency substitution can be full or partial. Full currency substitution can occur after a major economic crisis, such as in Ecuador, El Salvador, and Zimbabwe. Some small economies, for whom it is impractical to maintain an independent currency, use the currencies of their larger neighbours; for example, Liechtenstein uses the Swiss franc. Partial currency substitution occurs when residents of a country choose to hold a significant share of their financial assets denominated in a foreign currency. It can also occur as a gradual conversion to full currency substitution; for example, Argentina and Peru were both in the process of converting to the U. S. dollar during the 1990s.

"Dollarization", when referring to currency substitution, does not necessarily involve use of the United States dollar. The major currencies used as substitutes are the US dollar and the euro.

After the gold standard was abandoned at the outbreak of World War I and the Bretton Woods Conference following World War II, some countries sought exchange rate regimes to promote global economic stability, and hence their own prosperity. Countries usually peg their currency to a major convertible currency. "Hard pegs" are exchange rate regimes that demonstrate a stronger commitment to a fixed parity (i. e. currency boards) or relinquish control over their own currency (such as currency unions) while "soft pegs" are more flexible and floating exchange rate regimes. The collapse of "soft" pegs in Southeast Asia and Latin America in the late 1990s led to currency substitution becoming a serious policy issue. A few cases of full currency substitution prior to 1999 had been the consequence of political and historical factors. In all long standing currency substitution cases, historical and political reasons have been more influential than an evaluation of the economic effects of currency substitution. Panama adopted the US dollar as legal tender after independence as the result of a constitutional ruling.

There are two common indicators of currency substitution. The first measure is the share of foreign currency deposits (FCD) in the domestic banking system in the broad money including FCD. The second is the share of all foreign currency deposits held by domestic residents at home and abroad in their total monetary assets.

Unofficial currency substitution or de facto currency substitution is the most common type of currency substitution. Unofficial currency substitution occurs when residents of a country choose to hold a significant share of their financial assets in foreign currency, even though the foreign currency is not legal tender there. They hold deposits in the foreign currency because of a bad track record of the local currency, or as a hedge against inflation of the domestic currency. Official currency substitution or full currency substitution happens when a country adopts a foreign currency as its sole legal tender, and ceases to issue the domestic currency. Another effect of a country adopting a foreign currency as its own is that the country gives up all power to vary its exchange rate. There are a small number of countries adopting a foreign currency as legal tender. Full currency substitution has mostly occurred in Latin America, the Caribbean and the Pacific, as many countries in those regions see the United States Dollar as a stable currency compared to the national one. For example, Panama underwent full currency substitution by adopting the US dollar as legal tender in 1904. This type of currency substitution is also known as de jure currency substitution. Currency substitution can be used semiofficially (or officially, in bimonetary systems), where the foreign currency is legal tender alongside the domestic currency. In literature, there is a set of related definitions of currency substitution such as external liability currency substitution, domestic liability currency substitution, banking sector's liability currency substitution or deposit currency substitution, and credit dollarization. External liability currency substitution measures total external debt (private and public) denominated in foreign currencies of the economy. Deposit currency substitution can be measured as the share of foreign currency deposits in the total deposits of the banking system, and credit currency substitution can be measured as the share of dollar credit in the total credit of the banking system.

One of the main advantages of adopting a strong foreign currency as sole legal tender is to reduce the transaction costs of trade among countries using the same currency. There are at least two ways to infer this impact from data. The first is the significantly negative effect of exchange rate volatility on trade in most cases, and the second is an association between transaction costs and the need to operate with multiple currencies. Economic integration with the rest of the world becomes easier as a result of lowered transaction costs and stabler prices. Rose (2000) applied the gravity model of trade and provided empirical evidence that countries sharing a common currency engage in significantly increased trade among them, and that the benefits of currency substitution for trade may be large. Countries with full currency substitution can invoke greater confidence among international investors, inducing increased investments and growth. The elimination of the currency crisis risk due to full currency substitution leads to a reduction of country risk premiums and then to lower interest rates. These effects result in a higher level of investment. However, there is a positive association between currency substitution and interest rates in a dual currency economy.

Official currency substitution helps to promote fiscal and monetary discipline and thus greater macroeconomic stability and lower inflation rates, to lower real exchange rate volatility, and possibly to deepen the financial system. Secondly, official currency substitution imposes stronger financial constraint on the government by eliminating deficit financing by issuing money. An empirical finding suggests that inflation has been significantly lower in economies with full currency substitution than nations with domestic currencies. The expected benefit of currency substitution is the elimination of the risk of exchange rate fluctuations and a possible reduction in the country's international exposure. Currency substitution cannot eliminate the risk of an external crisis but provides steadier markets as a result of eliminating fluctuations in exchange rates. On the other hand, currency substitution leads to the loss of seigniorage revenue, the loss of monetary policy autonomy, and the loss of the exchange rate instruments. Seigniorage revenues are the profits generated when monetary authorities issue currency. When adopting a foreign currency as legal tender, a monetary authority needs to withdraw the domestic currency and give up future seigniorage revenue. The country loses the rights to its autonomous monetary and exchange rate policies, even in times of financial emergency. For example, former chairman of the Federal Reserve Alan Greenspan has stated that the central bank considers the effects of its decisions only on the US economy. In a full currency substituted economy, exchange rates are indeterminate and monetary authorities cannot devalue the currency. In an economy with high currency substitution, devaluation policy is less effective in changing the real exchange rate because of significant pass through effects to domestic prices.

High and unanticipated inflation rates decrease the demand for domestic money and raise the demand for alternative assets, including foreign currency and assets dominated by foreign currency. This phenomenon is called the "flight from domestic money". It results in a rapid and sizable process of currency substitution. In countries with high inflation rates, the domestic currency tends to be gradually displaced by a stable currency. At the beginning of this process, the store of value function of the domestic currency is replaced by the foreign currency. Then, the unit of account function of the domestic currency is displaced when many prices are quoted in a foreign currency. A prolonged period of high inflation will induce the domestic currency to lose its function as medium of exchange when the public carries out many transactions in foreign currency. Ize and Levy Yeyati (1998) examine the determinants of deposit and credit currency substitution, concluding that currency substitution is driven by the volatility of inflation and the real exchange rate. Currency substitution increases with inflation volatility and decreases with the volatility of the real exchange rate.