Why do some countries use another nation’s currency as legal tender?

Summary: Why Countries Sometimes Adopt Another Nation’s Currency

Facing recurring currency crises, wild inflation, or chronic distrust in their own money, some countries have chosen a radical route: making a foreign currency—usually the US dollar or the euro—their official legal tender. This is called "dollarization" or "euroization." It's not just a quirky economic move; it's often a survival tactic, sometimes controversial, and nearly always a story packed with trade-offs. In this article, I’ll walk through why governments make this leap, how it plays out in practice (with messy real-world details), and what experts, laws, and data say about the consequences. I’ll also compare how different countries and organizations treat the concept of "verified trade"—since international standards and recognition play a big part in these decisions.

What Problems Does Adopting a Foreign Currency Solve?

Imagine living in a country where yesterday’s wages buy half as much bread today. That’s not just a bad day—it’s a national nightmare. I remember talking to a shopkeeper in Quito, Ecuador, who had to change his prices every morning because the value of the sucre was plummeting. The stress was palpable. For him, the idea of switching to a stable currency like the US dollar was almost a relief.

Countries facing the following issues often consider dollarization or euroization:

• Hyperinflation: Local currency devalues so rapidly that prices are a moving target. Zimbabwe in the late 2000s is a textbook example—people literally carried bags of cash for basic groceries.
• Loss of Confidence: Citizens and investors stop trusting the local currency or central bank (sometimes for good reason—think of Argentina’s serial defaults).
• Financial Instability: When local banking systems collapse, people hoard dollars or euros anyway. The government just makes it official.
• Trade and Investment: Using a stable, recognized currency can reduce transaction costs, attract investment, and make international trade smoother.

So, when a country’s own money becomes more trouble than it’s worth, adopting a foreign currency can promise stability, predictability, and a shot at economic recovery—even if it comes with a loss of monetary "sovereignty."

How Dollarization or Euroization Actually Happens (Real Process, Not Just Theory)

Let’s get concrete. I’ve seen the news headlines, but the on-the-ground process is rarely simple or smooth. Here’s a rough, step-by-step walk-through, with a dose of reality thrown in.

1. Government Announcement and Legal Change:

   Official dollarization starts with a law or decree. For example, Ecuador passed its dollarization law in early 2000 (IMF Country Report No. 00/125). This law usually ends the central bank’s ability to print local money and makes the foreign currency legal tender for all debts and transactions.

2. Exchange and Conversion:

   The government sets a conversion rate between the old money and the new. This is often controversial. In El Salvador, the colon was pegged 8.75 to the dollar, but people complained prices were rounded up.

   Photo: A 2000 Ecuadorian government notice about exchanging sucres for US dollars (source: Wikimedia Commons)

3. Physical Cash Logistics:

   This is a logistical headache. The government needs to import massive quantities of foreign bills and coins—sometimes in the dead of night, under armed guard. There are always hiccups. In Ecuador, I heard stories of rural banks running out of small change, so people bartered or gave candy instead of coins.

4. Public Education Campaign:

   People need to learn how to use the new money—how to count it, price goods, and avoid scams. This is all-too-real: I met a taxi driver in El Salvador who accidentally accepted a $20 bill thinking it was a $2 note (they look nothing alike, but stress and confusion do funny things).

5. Banking and Contracts Transition:

   All bank accounts, loans, and contracts have to be converted. This is where legal disputes erupt—imagine having a loan in old currency and suddenly owing dollars at the new rate. Sometimes, courts get involved.

Real-World Effects: The Good, the Bad, and the Unexpected

No policy is all upside. Let’s look at what actually happens post-dollarization, mixing expert analysis with ground-level stories.

Stability and Investment: The Main Appeal

The most obvious benefit is monetary stability. Inflation typically drops sharply. According to National Bureau of Economic Research, Ecuador’s inflation fell from over 90% in 2000 to under 10% by 2004. Foreign investors, who hate currency risk, sometimes come back.

But it’s not a free lunch. Countries lose control over monetary policy—no more devaluing the currency to boost exports, and no way to print money in a crisis. When global downturns hit, dollarized economies can get stuck. Panama’s experience since the early 1900s shows long-term stability, but also chronic unemployment spikes when the US sneezes.

Social Fallout and Inequality

I’ve heard people complain that prices rise faster than wages after dollarization. There’s some truth: merchants round up, and the poorest—those with no savings to cushion the change—often get hit hardest. The UN Economic Commission for Latin America and the Caribbean found poverty actually rose in Ecuador in the immediate aftermath, before stabilizing a few years later.

Political and Legal Complications

Dollarization can also mean ceding some sovereignty. In Zimbabwe, after adopting the US dollar, the government couldn’t run large budget deficits (since it couldn’t print money), which forced austerity. There are also legal tangles—what happens if the US or EU changes coin designs, or decides to demonetize certain bills?

Here’s a snippet from a 2019 IMF report on Zimbabwe:

“Dollarization stabilized prices but limited macroeconomic policy flexibility and created severe cash shortages, as the authorities had no control over the supply of US dollars.” (IMF Working Paper 19/219)

Comparing Verified Trade Standards: Why International Norms Matter

When a country changes its currency, it also affects how it participates in global trade. Certification, customs valuation, and trade documentation all reference official legal tender. Different international organizations and countries have their own standards for what counts as "verified trade"—which can lead to headaches if you’re an exporter, importer, or just a compliance geek like me.

When a country dollarizes, it has to make sure its trade documentation and customs rules sync up with global standards—otherwise, exports can get stuck, or importers might face fines due to mismatched paperwork.

Case Study: How Verified Trade Disputes Get Resolved

Let’s say Country A (El Salvador, which uses the US dollar) and Country B (the EU) disagree on the authenticity of a trade invoice. Maybe the EU questions whether a Salvadoran exporter’s invoice is valid, since it’s denominated in dollars, not euros. Here’s how it might play out:

• First, customs authorities check if the document meets their own legal requirements (see above table).
• If there’s a dispute, the case might go to the WTO’s Dispute Settlement Body, as outlined in the WTO rules.
• Experts or trade lawyers argue over whether the foreign currency is acceptable, citing international agreements, domestic law, and precedent.

In a 2021 webinar, trade lawyer Ana Gutierrez (no relation to me, but I remember her talk!) said:

“In practice, as long as the currency is legally recognized in the exporting country, most customs agencies will accept it. Problems arise when documentation is inconsistent or when currency controls are suddenly imposed.”

So, real-world disputes usually get resolved by referencing international norms and domestic legal recognition.

Expert Insights: Is Adopting Another Currency Worth It?

I asked a couple of economists (one from the OECD, another who works with the World Bank in Ecuador) what they think. The consensus? Dollarization can stabilize an economy in crisis, but it’s no panacea. If the underlying problems—like government overspending or a broken banking sector—aren’t fixed, even the world’s most stable currency won’t work miracles.

One expert put it bluntly: “Dollarization is like going on a diet by throwing out all the junk food in your house. It helps, but if you don’t change your habits, you’ll just find new ways to cheat.”

Conclusion and Reflections

Adopting another country’s currency is one of those rare economic moves that’s both dramatic and, sometimes, desperate. It solves some problems—mainly runaway inflation and currency collapse—but creates new ones, like loss of monetary control and potential social pain. In my own experience watching Ecuador’s transition, the initial confusion was real, but within a few years, most people appreciated the new stability.

If you’re a policymaker, business owner, or just a traveler, my advice is to watch the details: check how contracts are rewritten, make sure your trade paperwork matches new standards, and keep an eye on how both local and global organizations treat currency and trade recognition. For further reading, the IMF, OECD, and WTO all have deep dives on these issues (IMF Zimbabwe report, OECD dollarization brief, WTO TFA).

Final thought: there’s no one-size-fits-all answer. Each country’s story is a little bit different—and sometimes the right move is the one that just barely keeps the wheels on during a wild ride.

Summary: How Adopting a Foreign Currency Can Rescue an Economy from Chaos

Imagine waking up one morning in a country where prices double every week, your savings melt away overnight, and every paycheck is a gamble against the next currency crash. For many, this isn’t just a nightmare—it’s a lived reality. That’s why some countries, desperate for stability, ditch their own faltering money and instead adopt a foreign currency like the US dollar or euro as legal tender. This bold move, often called dollarization or euroization, isn’t just a last resort; it’s a calculated attempt to anchor an economy that’s spinning out of control. But as I learned firsthand while working on a consulting project in Ecuador, the process is anything but straightforward.

The Immediate Problem: Hyperinflation and Currency Collapse

In the late 1990s, I was helping a small manufacturing business in Quito manage its finances. Every week, our accountant would scribble out new prices as the sucre—Ecuador’s then-currency—lost value. Suppliers wanted to be paid in dollars, customers hoarded US bills, and nobody trusted the central bank. Fast forward to January 2000: the government announced the sucre would be replaced by the US dollar. It was chaos for a few months, but then something remarkable happened—prices stabilized, and business planning became possible again.

That turnaround wasn’t unique. Many countries have considered or implemented foreign currency adoption. But what drives that decision? Here’s how the process typically unfolds, with some surprising twists.

Step by Step: How (and Why) Countries Switch to a Foreign Currency

1. Loss of Confidence in the Local Currency
   The trigger is usually runaway inflation, severe currency devaluation, or a catastrophic banking crisis. In Zimbabwe (2009), the government abandoned the Zimbabwean dollar after inflation reportedly reached 89.7 sextillion percent (IMF data). People simply stopped using the local currency, transacting instead in US dollars or South African rand.
2. Informal Dollarization
   Even before official action, businesses and individuals start using a stable foreign currency for large transactions or savings. This bottom-up shift often forces governments to make it official.
3. Legal Adoption
   The government passes legislation (sometimes overnight, as in Ecuador) declaring the foreign currency legal tender. All contracts and wages are henceforth denominated in the new anchor currency.
4. Banking System Overhaul
   Banks must convert existing accounts, ATMs, and payment systems. In my own experience, the conversion period is tense—everyone’s watching exchange rates anxiously, and there are always rumors of price gouging or “rounding errors.”
5. Aftermath: Economic Stabilization
   Inflation typically plummets, confidence returns, but the country loses control over its own monetary policy.

Screenshots from Practice (Simulated)

Here’s a simulated bank system screenshot from when we helped a regional credit union in Ecuador update their software in 2000:

Note the “Convert All Balances” button—one click, and every account in the system changed from sucres to dollars at the government-mandated rate. Simple in theory, but in practice, it required weeks of reconciliation and frantic customer support.

What Do Countries Gain—and Lose—by Surrendering Their Currency?

Let’s break down the main effects, both positive and negative, based on my own research, hands-on consulting, and interviews with experts.

• Stability and Lower Inflation: The biggest gain is credibility. Adopting a strong foreign currency instantly curbs hyperinflation and restores savings. According to the OECD, Ecuador’s inflation dropped from over 90% in 2000 to single digits within two years of dollarization.
• Loss of Monetary Policy Tools: The downside is stark: no more local interest rate adjustments or currency devaluation to boost exports. When the next crisis hits, the central bank has very few levers left.
• Banking Sector Risks: Banks must import physical cash (expensive!) and manage liquidity with fewer tools. In El Salvador, during early euroization, a sudden demand for dollars caused short-term cash shortages, according to a 2001 IMF working paper.
• Loss of Seigniorage: The government no longer earns profits from printing its own money (seigniorage), which can be a significant loss to the national budget.
• Trade and Investment: Foreign investors often feel more confident when a country uses a stable currency, but exporters might struggle if the new currency is “too strong” for local productivity.

Real-World Case Study: Ecuador’s Dollarization Gamble

I’ll never forget the day the local papers in Quito announced the dollar was now official currency. Overnight, street vendors were quoting prices in dollars, and banks handed out crisp US bills (often in the wrong denominations—try buying groceries with a $100 bill!). According to data from the World Bank, GDP growth rebounded from -4.7% in 1999 to positive territory within a year, although poverty rates remained stubborn for a while.

But not everything was smooth. Local businesses that exported flowers and bananas suddenly faced stiffer competition, since they could no longer devalue the currency to stay competitive. A florist I spoke with in 2001, María, complained that “dollar prices are high for Americans, but for us, everything imported is expensive now.” She wasn’t alone—many small exporters struggled, while importers thrived.

Expert Insights: Is Dollarization a Long-Term Solution?

To get a broader view, I reached out to Dr. Julio Velasco, a Latin American economist who’s advised several governments on currency policy. As he told me in a 2023 interview, “Dollarization is a shock treatment. It works best when institutions are weak and alternatives are worse. But you lose your own policy tools. For most countries, it should be a last resort, not a first choice.”

That lines up with the cautious stance taken by the IMF: “Official dollarization can help restore confidence and stabilize prices, but it also means surrendering monetary autonomy and may require extensive structural reforms.”

Cross-Border "Verified Trade" Standards: A Comparative Table

Here’s a quick breakdown of how major economies verify cross-border trade, an issue that becomes crucial when you’re suddenly using someone else’s currency:

For more details, the WTO Trade Facilitation Agreement provides an overview of international standards. But each country’s approach reflects local priorities—something you can’t ignore when you lose control over your own money.

A Simulated Dispute: When “Verified Trade” Gets Messy

Let’s say Ecuador (using the US dollar) tries to export shrimp to the EU. The EU’s AEO program requires electronic traceability, but Ecuador’s documentation—still catching up after the currency switch—doesn’t meet the standard. Suddenly, a shipment is delayed, and a major importer loses millions. In a real-life forum post on Trade Finance Global, an exporter complained: “We had to hire a consultant just to translate our paperwork, and still customs flagged our containers. The dollar helps for payments, but trade rules are a different headache.”

That’s the kind of detail most textbooks miss. Currency stability is great, but if your administrative systems can’t keep up, you hit new roadblocks.

Personal Takeaways, Mistakes, and Final Thoughts

Looking back, I have mixed feelings about foreign currency adoption. On the ground, it brings instant relief—no more wild price swings, no more panic. But as I saw with my Ecuadorian colleagues, it doesn’t fix underlying problems. Businesses still face bureaucratic headaches, and governments lose powerful tools for economic management.

If you’re a policymaker, think carefully before giving up your currency. It’s a tool you might desperately need someday. But if you’re living through hyperinflation, as my friends in Zimbabwe did, sometimes the only way out is to tie yourself to a stronger anchor—no matter the loss of autonomy.

For anyone interested in the technicalities or considering the move, I’d recommend digging into IMF and OECD reports, talking to local businesses, and maybe even simulating a currency switch in your own accounting system. But be ready for surprises—the real world rarely follows the textbook script.