U.S. Dollar in Panama
One of the reasons the Republic of Panama is a wonderful place to do business is because it does not have its own currency. That seems rather an incredible statement. Please follow along while I explain.
Panama, like any other sovereign nation, has a currency, so my statement is not 100% correct. Panama’s currency is the Balboa, which has been fixed to the U.S. dollar at a one to one exchange rate since 1904. Here’s why people mistakenly believe that Panama does not have its own currency – the Balboa only exists as a coin, and the largest denomination of coin is 1 Balboa. So trying to buy any pricey items using the local coinage would be cumbersome. You would need reinforced pockets, a belt and suspenders, to carry the equivalent of $50 US without losing your trousers! For currency amounts above 1 Balboa, merchants and businesses simply deal in and accept the U.S. dollar. Panamanian law allows the Balboa and the dollar to be accepted side by side.
I find the history of how this came to be quite interesting. Panama gained independence from Spain in the South American revolutions of 1821, as part of Colombia. Several attempts to break away from Colombia failed, but the Thousand Days War (1899–1902) nearly succeeded. When diplomacy between Colombia and the U.S. for the rights to a future canal project in Panama failed, the U.S. took advantage of the recent uprising.
The U.S. decided to support the Panamanian independence movement. President Theodore Roosevelt declared Panama an independent nation, and sent troops. In November 1903, Panama proclaimed its independence and a compliant government quickly signed the Hay/Bunau-Varilla Treaty with the U.S. The treaty granted rights to the United States “as if it were sovereign” in what became the “canal zone.” The U.S. was to build a canal, then administer, fortify, and defend it “in perpetuity.”
Law 84 of 1904, which created the Balboa only provided for the creation of gold and silver coins; the law did not provide for the issuance of paper currency. Article 8 of this law also provided that these coins were to be sculpted and minted by the U.S. Mint in Philadelphia. Most governments would find this inconvenient, but the advantages outweigh the inconveniences. In recent years, Argentina contemplated the advantages of this arrangement after currency speculators attacked the Argentine peso.
Unlike the U.S., Panama can not play monetary games like printing trillions of Balboa against its own bonds. Fiscal policy is the government’s macroeconomic policy instrument. This is the basis for my claim. Wise fiscal policy is paramount in the minds of officials at all times. Government spending and investment is bound by revenues and the government’s ability to borrow. Revenues come from creating an attractive environment for business, part of which appears in the form of a tax friendly environment. Panama’s creditworthiness is linked to public finances, and the government watches its credit measures like a hawk.
Panama has averaged less than two percent annual inflation since the 1960’s, but spiked to 2.3 percent in 2005, the worst figure in years. Panama’s economy is perhaps the healthiest in Latin America, likely due to this arrangement. A nice benefit of this is that Panama has no restrictions on the outflow of capital or outward direct investment.
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