Quora Answer: Why Do Countries Not Use the US Dollar instead of Just Pegging Their Currency to It?

The following is my answer to a Quora question: “Countries like the UAE, Qatar, and Hong Kong peg their currencies to the US dollar.  Why do they not just use the US dollar instead?  Is there an added advantage to having your own currency?” 

Using the currency of another country means losing sovereign control of your monetary and fiscal policy.  Central banks use these as tools to stimulate the economy, to control inflation, and to gain an advantage in trade relations.  They may also expand or restrict the money supply.  This can only be done with your own currency. 

If these economies use the US dollar, they are tied to the Federal Reserve.  The Federal Reserve uses monetary policy as opposed to fiscal policy, manipulating interest rates, to stimulate the economy or combat inflation in the US economy.  That is its primary tool.  They are focused on the American market.  Any other central bank using the US dollar is tied to this, regardless of their local economic condition, and the policies of a distant central bank may actually exacerbate a dire situation. 

Finally, we must consider the relatively smaller economies of these countries.  Because they are tied to the economic fortunes of an external central bank, there is likely going to be massive inflation in their own economies because the purchasing power parity is very different.  This will have a negative effect on the cost of living, lowering living standards in the interim, and accelerating an economic divide.  That is a recipe for political instability. 

These are three major economic reasons for having your own currency.  There are other reasons, specific to the countries named, tied to geopolitical and historical reasons.  Generally, it is a terrible idea to use another country’s currency as your own, for any sovereign entity.