Why Panama Dollarized

By Rasheed J. Griffith , law student at Universidad de las Hespérides.

Panama has been dollarized since 1904. Its constitution prohibits the creation of non-convertible paper money. In any discussion on Caribbean dollarization, Panama is a necessary element. But its monetary system is poorly understood, especially from a historical perspective. 

It is generally assumed that the US thrust dollarization upon Panama because of the Panama Canal Zone. But that is not true. The real history is far more interesting. 

The story begins with Panama's separation from Colombia in 1903 and traces back to Colombian monetary history of the late 19th century.

In mid-1800s Colombian politics, two main factions existed: federalists (favoring decentralization) and centralists. When Rafael Núñez, a centralist, became president in 1880, he led the "Regeneración" movement with the motto "One Nation, One People, One God," pushing for centralization of state power. Núñez created a state bank (Banco Nacional) and a national paper currency when private banks refused to fund his social infrastructure projects.

To build confidence in the paper currency, Núñez established the "Dogma of the 12 million", limiting currency issuance to three times national revenue (12 million pesos). However, this rule was broken during the Thousand Days War (1899-1902), when the government printed over 831 million pesos, causing massive inflation: 15.2% in 1899, 66% in 1900, and 389% in 1901.

At the end of the war, the new Colombian administration promulgated Decree 217, which stated the intent to abolish the issuance of paper money (“por el cual se suprimen las emisiones del papel moneda”). Monetary stability was successfully achieved after Congress eventually passed a bill based on that Decree in July 1903, officially prohibiting the issuance of paper money by the central government.

Panamanians were stridently opposed to the centralizing of the Colombian state under Núñez’s La Regeneración. Panama was the most prosperous state in the United States of Colombia since the mid-19th century, partly because of the Panama Railway Company. Moreover, Núñez’s policy was to extract more money from the Department of the Isthmus (Panama) via increased taxes and control of its fiscal surpluses. Inevitably, this caused great discontent. 

The exploitation exacerbated by the Thousand Days War (also with the USA “nudging”) led Panama to separate from Colombia in November 1903. At the birth of this new nation, the people there had inflationary trauma fresh in their minds. The new state kept Colombia's legal prohibition on state issuance of paper money. 

Interestingly, Colombia’s constitution, until 1910, still prohibited issuing paper money, but it was subsequently reformed (poorly, by US money doctors—a topic for a future post). Panama has maintained the original Colombian prohibition principle to this day.

Importantly, this original Article 117 of the 1904 Panamanian Constitution has been retained in every successive Panamanian Constitution, even after various military coups and dictatorships. The current constitution, which has been in force since 1972 (with amendments), retains the original principle and prohibition now under Article 262.

I’ve described why Panama does not have its own paper money today and the legal foundations of US dollar circulation in the country. But a question immediately follows: why USD at all and not some other sound foreign currency? To understand why Panama uses the USD, we need to know about the creation and politics of the Panama Canal Zone.

While we've uncovered why Panama lacks its own paper currency, the story of how the US dollar became the country’s legal tender reveals surprising twists. Join us for the second part of this story on Friday, November 15, as we delve into the negotiations with Secretary Taft and the monumental decisions that shaped Panama’s financial future.