Currency Substitution

You find yourself in a bar in Panama, listening to “Panama” by Van Halen on a jukebox. You need to put $1 into the Jukebox to send David Lee Roth’s voice screaming into the night. You aren’t going to be using Panama’s national currency, because Panama doesn’t have an official currency. Instead, the country engages in something known as “currency substitution,” and uses the U.S. dollar as its official currency.

This practice is very common in nations that either lack a central bank or don’t have a foreign currency traded on foreign exchanges (FX). The advantages of using another nation’s currency is that it provides you stability by using the foreign currency due to the massive demand. However, the primary disadvantage is that you have no control of the currency, or the fiscal and monetary policies that impact its value.