Dollarization: The Ties That Bind Countries Together

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The Basic Premise of Dollarization

An important concept that comes into play in the forex markets is that of dollarization. Many countries have their own currencies though some choose to band together in a unified economic front. The Euro being representative of several European countries is an excellent example. A country may choose to adopt another country’s currency rather than printing their own for use on the world stage. Like anything, it has benefits and drawbacks. The announcement is typically followed by a drastic fluctuation due to the weighing economic factors.

El Salvador, for example, uses the United States Dollar as its national currency. Though it does, it does not have any right to print United States Dollars or take major actions to affect its value and position. It simply chooses to deal using the Dollars that are in circulation that they generate through their economy.

How Dollarization Benefits Forex Traders

Volatile areas such as Europe present some turbulent, yet potentially profitable waters. The financial problems of Greece are no big secret to anyone. Values on the Euro were rattled as austerity talks were mentioned and the European Union debated on what exactly to do
about the Greek problem. Some countries wanted to cut them loose, others wanted to infuse their country with bailout funds to prop them up enough to regain their footing.

The Euro was affected by the Greek news on an almost daily basis. Fluctuations would coast back and forth providing fuel to United Kingdom sentiment that they should never sacrifice the Great Britain Pound for the Euro. Rightly so as the Great Britain Pound is the second most traded currency behind the United States Dollar.

Keeping an eye on the European sector is a good move for those who trade currencies. If another turbulent patch hits leaving another country in the same position Greece found itself in, a number of opportunities will show to the observer. Prediction is doom and gloom? Time to go short against the Euro. Happy days are ahead again as financial stability is attained? Good chance a long position on the Euro will reap a benefit.

Countries that operate under the dollarization principal inexorably link the well-being of their economy to the whole value of a given currency. In the case of the European Union, letting one of their member countries fall would have meant that they all suffered for it. Instead, you have several countries trying to help their member to their feet which should mean improved values as more currency flows thanks to dollarization.

Difficult Implications of Dollarization

A member nation of the EU may fail to stabilize if there is not enough supporting structure behind the action. Greece and Spain are prime examples. Greece’s economy is not in a condition to support the revitalization that was hoped for by pumping more Euros in. Thus, the EU and Greece find themselves in the unenviable position of deciding whether or not to cut Greece loose. Though Angela Merkel’s leadership kept the EU on course for a fair amount of time, her support is eroding due to a failure to find a solution for the problems plaguing Greece’s affect on the euro.

Spain is a good example of that erosion. Though Merkel did not back bail outs for Spain’s financial sector, the rest of the EU found it prudent to push through the aid package. Though Greece was hit with a number of austerity measures, Spain coupled those measures with a significant overhaul of their financial sector regulations. Spain has a much better chance of weathering through their economic downturn than Greece because they took greater measures to repair what was broken before pushing more euros into their economy.

The circumstances with Spain and Greece has caused a significant downtrend for the euro’s value. Manufacturing data from the major players in the EU helps to bolster and provide pullbacks in the value. However, the overall trend will require a significant jolt and good news out of the euro zone to force a reversal. The expulsion of a member state will not provide a predictable response. Since the forex market is driven by the interpretations of the participants; one would have to guess between viewing an expulsion as a sign of cutting dead weight or as a precursor to something worse.

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