Policymakers Shouldn't Fear Digital Money: So Far It's Maintaining the Dollar's Status

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"An awful lot of our international power comes from the fact that the dollar is the standard unit of international finance and transactions. Clearing through the NY Fed is critical for major oil and other transactions, and it is the announced purpose of the supporters of cryptocurrency to take that power away from us, to put us in a position where the most significant sanctions we have on Iran for example would become irrelevant."

The bottom-up model occurs in a spontaneous manner, as citizens flee a depreciating local currency and adopt the dollar, even when dollar holdings might be criminalized or where capital controls exist.

Soft dollarized countries may have a soft or crawling peg relative to the dollar or may not treat it as legal tender at all; regardless it has widespread usage due to its desirable properties.

Dollarization events generally follow specific catalysts: in Ecuador, users adopted the dollar in response to the devaluation of the sucre following a banking crisis, and the government ultimately capitulated.

Following the collapse of the Soviet Union, virtually the entirety of Eastern Europe, the Baltics, the Caucuses, and Central Asia dollarized in a partial way, with the dollar penetrating 20-30 percent of the money supply in these regions in 1993, and growing to the 30-40 percent range in 2001.

There is good evidence that abandoning an inflationary currency and establishing a dollar standard tends to index local inflation to the U.S. rate, increase foreign domestic investment, and increase local lending and financial sector activity.

The reason? According to American Institute for Economic Research, the Zimbabwe government essentially confiscated dollars in bank accounts by forcing commercial banks to swap dollar deposits for "Zimbabwe bonds." After ATMs and banks stopped dispensing cash, a mismatch between these electronic pseudo-dollars and the value of physical dollar banknotes developed.

"For people working in the formal economy - accountants, retail workers, engineers and so on, everyone now uses electronic dollars, which are simply represented by numbers in a bank account. These electronic dollars are worth about half what a U.S. dollar is worth on the street, according to local observers."

The potential for confiscation of dollar deposits in the banking system by capricious governments has interfered with dollarization.

These are commonly referred to as "Stablecoins": crypto-assets serving as an IOU representing a dollar in a bank account.

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