What will happen if a country suddenly decide to use other currency (stronger currency) to run their economic and completely ignore it’s …

economy : What will happen if a country suddenly decide to use other currency (stronger currency) to run their economic and completely ignore it's own currency?
Because the country's own currency always fluctuates uncontrollably and causing the business a massive loss. And is it possible?

Answer by Balaji Viswanathan:

A country can decide to use another country's currency. It is termed Currency substitution. For instance, 6 decades ago Indian rupee was the currency used in many parts of Asia – West, South and South East.

It is usually an extreme step and is an indication of deeper problems. For instance, Zimbabwae unofficially uses US dollar after a period of massive hyperinflation.

Currency decides sovereignty

When you are giving up your currency, you are giving up control over your financial sovereignty. You are at the mercy of an another nation. This is what Europe is going through. They have brought a common currency – Euro – without bringing a (strong enough) common government.

Let's take the case of Greece. After the adoption of Euro, Greek worker salaries went up in absolute terms. It was costing a lot of money to pay a Greek worker to build a car compared to a German worker who can build a car. The German worker was way more productive but still was making only a little more than a Greek worker. When such a thing happens, one of the following must happen:

  1. Greece loses jobs to Germany as it is much cheaper for a German worker to build a car. This will lead to high unemployment.
  2. Greece can cut salaries to its workers. This will not be accepted by the unions. No worker likes salary cut.
  3. Greece can inflate its own currency that will indirectly cut the worker's salaries. This is the least painful of the 3 options, but Greece had no currency of its own to inflate.

Countries need their own currencies to finetune the growth. If inflation grows high, it can reduce currency circulation and if growth slows down, it can increase currency circulation. These levers are needed to ensure a smooth economy.

Managing fluctuations

There are various ways to manage currency fluctuations:

  1. Central bank [such as the Reserve Bank of India] actively managing the market to smooth the money flow.
  2. Strengthening the financial market so that businesses can buy currency forwards to reduce the risk. For instance, if I'm an exporter who worries about rupee going up, I need to find an importer who is worried about rupee going down. We both can enter into a contract to exchange rupee at a fixed rate. This is the common practice all over the world.

What will happen if a country suddenly decide to use other currency (stronger currency) to run their economic and completely ignore it's …

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