This stark reality has financial architects increasingly considering the prospects for dollarizing countries around the region. Yet most dollarization analysis is based on theory. Panama's dollarization experience since 1904 is dismissed by many because the country is small. Nevertheless, the Panamanian case is useful in understanding the advantages of dollarization, as a means of eliminating local currency risk against the dollar. The most important lesson is that a country that dollarizes must liberalize its banking system in order to achieve the full benefits of the anchor.
Financial liberalization is in fact the driver behind Panama's price and financial stability.
In many ways, Panama's dollarization experience speaks for itself. Credit is ample, with 30-year mortgages readily available. These are unusual conditions for a developing country and are largely achieved because there is no exchange-rate risk, a low risk of financial crises, and ample flow of funds from abroad. Government and private bank bonds are classified Ba1 or better. Yet it is important to recognize that it is not dollarization per se which has brought so much stability to Panama but rather dollarization together with a 1970 banking law that allowed Panama's monetary system to integrate with world financial markets.