Okay, here's the set-up. In 1903, the U.S. sponsored the independence of a mercantile breakaway region of Colombia in a strategically very intriguing location. The constitution of this new country permanently linked its new currency, the balboa, one to one with the dollar. In 1914, the Panama Canal was opened. Canal Zone policy did not allow sales to ships on credit. Banks in Panama filled the gap.
Jump-cut bone to space station here. Seventy years after, in a region whose major products were coffee, bananas, and death squads, Panama managed to seize this tiny bit of comparative advantage and leverage it into a national economy centered around financial services. Swiss-style bank accounts, generous corporate tax policies, and a major re-exporting hub, combined with the use of the U.S. dollar and the low inflation caused by the Balassa-Samuelson effect: all these things made Panama an attractive site for many types of business activity.
Small problem: Manuel Noriega. A scary guy, and I'm not talking about the acne. He was the chief of secret police for the charismatic leftist populist Chicago-influenced leader of Panama, General Omar Torrijos, and the guy who (in theory) was going to disable the Panama Canal if the 1977 treaty didn't go through; and after Torrijos's plane mysteriously crashed in 1981, Noriega quickly moved to consolidate power behind the scenes. Money laundering, drug smuggling, dogs and cats living together, mass kleptocracy. One of the cuter scams was that Noriega's associates ran the company responsible for security in the re-export zone. Guess how that worked.
Now, somehow Noriega had got on the bad side of Uncle Sugar. It's rather difficult to pin down the proximate cause, since the fellow had been messing with drugs and money since the 1970s, when he was heavy petting with the CIA, but whatever. Suffice it to say that by the late 1980s, Noriega had turned from “our bastard” to “liability” in the eyes of the Powers That Be. The change might even have been made in good faith. Manuel Noriega was indicted in a Miami court on February 4, 1988. On March 3, 1988, all the U.S. accounts of the Banco Nacional de Panama were frozen. The Assistant Secretary of State for Inter-American Affairs, Elliott Abrams, gloated to the press about this neat idea, quipping like only an apparatchik can: “Noriega is hanging on by his fingertips. He'll be out of power in a week. Now we'll see who stole the strawberries.” But it was a neat idea, if not very well thought through.
Here's the thing: because Panama has no independent currency, it relies on dollar flows from the U.S. to maintain financial liquidity. Panama has no central bank. Balboa notes have only been issued once, in a bizarre episode in the early 1940s, and they were all cancelled. So the mechanism to maintain Panama's financial liquidity was deliberately cut off. When this happens on a widespread scale, it's called a depression. After all, as the history of the twentieth century tells us, nothing causes dictators to lose power more quickly than a depression. The BNP had to close its doors, and other Panamanian banks followed. It gets better. The BNP, while not a central bank, is the Panamanian clearinghouse for cashing checks. Since Panama had a modern, service-based economy, this made the next payday (March 14) problematic. A general strike quickly ensued. Noriega had an ingenious scheme: pay the workers in commemorative coins! This was nixed by the money mavens on hand. So, all in all, a lot of calamity, a lot of hardship.
Why didn't it work? It took Operation Just 'Cause (originally named Operation Blue Spoon, which I think is much cooler) to oust Noriega. The sanctions did manage to reduce the Panamanian economy by a third, maybe a half, for over a year, precipitating a decade-long jump in unemployment. But that doesn't mean much to a dictator. It's almost the definition: a dictator is a leader who is unresponsive to the popular will. But a major reason it didn't work was that the Panamanian financial system was remarkably resilient.
The Panamanian bankers weren't unsophisticated rubes fresh off the coffee finca. Some of them went to the University of Chicago. They had long practice finding loopholes and workarounds against Uncle Sugar's more anti-Panamanian rulings; they had a decades-long institutional history of doing this. So the government issued fractional pay checks which could circulate like bills of exchange, increasing the effective money supply. Noriega himself set up Eurodollar accounts using laundered drug money -- sweet of him, and part of the reason he's getting a French vacation -- so that the BNP could finally clear checks and credit card bills. Some banks issued CDs based on savings accounts, which were used for big ticket items.
In short, just as the Great Depression sparked a wave of industrial innovation in the U.S., the U.S.-engineered depression sparked a wave of financial innovation in Panama. The other reason is, private companies sent Panama a lot of dollars so their Panamanian enterprises could stay afloat. Texaco, United Fruit Brands, Eastern Airlines. Not a whole lot in absolute figures, but it helped at the margin. After all, politics is politics, but business is forever. (PS: Doug, I know the exact word that's tickling the back of your head -- Komarr.)