The Dollar is the official currency of the United States and its territories, but, also, some other countries use it as their official currency too. In fact, the U.S. dollar is known as the world’s reserve currency.
More than $1.8 trillion of U.S. currency is now in circulation around the world, and it’s believed that two-thirds of $100 bills and nearly half of $50 bills are held outside the US. In fact, the U.S. dollar is the de facto global currency, meaning it’s kept by many governments in reserves and that most people and companies trust it for international trade.
Even as the coronavirus pandemic wreaked havoc across global markets, wiping out trillions of dollars’ worth of assets, the U.S. dollar was unaffected by the turmoil. At one point, it soared 4% against a basket of major currencies, namely the euro, pound, yen, Canadian dollar, Swiss franc, and Swedish Rona. So why did we see this spike in the value of the U.S. dollar?
How exactly did its become so powerful
The dollar is strong because of the U.S. economy and because people want to hold dollars and the safety of the U.S. dollar. In times of uncertainty, investors flee to what’s known as safe havens, investments expected to hold their value during market turbulence. And you guessed it, the U.S. currency is seen as such. Why?
Well, it hails from the world’s largest economy, the United States, which is generally politically and economically stable. And while you can be pretty sure that the U.S. dollar’s value will fluctuate, it probably won’t plunge the way the Turkish Lira or Argentinian Peso have. All of that demand for the dollar can cause shortages during times of economic crisis, which only exacerbates the larger problem.
America’s central bank, the Federal Reserve, is responsible for issuing the currency and takes extra measures to prevent a squeeze when there’s a rush for the greenback. For example, during the financial and coronavirus crises, it set up a number of ‘swap lines’ with other major central banks, making sure there is enough money available for investment and spending.
This helps stabilize currency markets when the desire for the U.S. dollar surges. So how exactly did the U.S. dollar become the major reserve currency of the world? Well, for a long time, developed economies tied their currencies to gold.
Dollar during the warld war
However, during the first World War, many of these countries abandoned this gold standard and started paying their military expenses with paper money instead. Eventually, the U.S. dollar, which was still tied to gold, overtook the British pound to become the world’s leading reserve currency.
During World War II, the United States sold weapons and supplies to many of its allies and collected its payments in gold. By 1947, the U.S. had accumulated 70% of the world’s gold reserves, leaving other nations with a huge disadvantage. To try to remedy this and other financial matters, 44 Allied countries met in Bretton Woods, New Hampshire, in 1944.
There, they decided that the world’s currencies would be pegged to the U.S. dollar, which was in turn linked to gold. As central banks began to build their reserves over time, these dollars were redeemed for gold, dwindling the U.S.’s stockpile and igniting concerns about the stability of the U.S. dollar.
The dollar get de-linked from gold
In 1971, U.S. President Richard Nixon shocked the world when he de-linked the dollar from gold. From there, free floating exchange rates were born, meaning exchange rates were no longer fixed to gold and were determined by market forces instead.
Despite periods of market volatility and the inflation that followed, the U.S. dollar has remained the world’s reserve currency. Its sheer volume and America’s efficient banking system made the notes more convenient and cheaper to trade than other currencies.
Today, the vast majority of foreign exchange transactions are done in U.S. dollars with no other currencies coming anywhere near that. In recent decades, the U.S. has even been accused of “weaponizing” its currency for strategic and geopolitical influence.
One example cited by critics was the Trump administration’s sanctions on North Korea and Iran, which included forbidding them from using the dollar in trade. Some economies are so reliant on the American notes, that they’re even commonly used in day-to-day transactions.
At ATMs in Cambodia, you can withdraw the greenback from the machines. On a global scale, you’ll find commodities like metals, energy and agricultural goods are usually traded in U.S. dollars. Here’s an example of how the U.S. dollar influences everyday business deals.
How does the dollar influence business deals?
Let’s say a jewelry company in India wants to sell its products to a Canadian department store. If the Canadian retailer tries to pay in Canadian dollars, the Indian jeweler is likely to say, “I don’t know how much this is worth. And I certainly can’t use it in India.” That department store, meanwhile, could also argue that the rupee won’t go very far in Canada. So, they’re both likely to transacting U.S. dollars instead. Those dollars will then be exchanged into rupees in India. Add together the number of transactions happening like this every day and, well, that’s a lot of greenback entering foreign economies.
So, we’ve established that the U.S. dollars stable. But you might be thinking, what about other currencies that are stable too like what about the Swiss Franc or the Singapore dollar, both of which come from politically and economically stable countries too. And yes, while those are fair points, the truth is, those countries just have far less influence and economic power.
Switzerland’s population is a mere 8 million, while the U.S. has more than 332 million. Just look at central banks’ foreign exchange reserves worldwide. While the majority of currency reserves are made up of U.S. dollars, the euro makes up nearly 21%, the Japanese yen makes up nearly 6%and the pound sterling makes up nearly 5%. So, could any of these other currencies give the dollars a run for its money?
Alternative reserve currency
For years there have been calls for an alternative reserve currency, ranging from countries like China and Russia to intergovernmental organizations like the United Nations. In recent years, some central banks have added the Chinese yuan to their reserves. The cloud of U.S. sanctions has also prompted a desire for some countries to bypass dollar-denominated trading.
In 2018, Germany’s foreign minister wrote in an op-ed that it is “essential that we strengthen European autonomy by establishing payment channels independent of the U.S.” And some are hoping the world’s future reserve currency won’t be tied to a national government at all.
They see cryptocurrencies, such as bitcoin, eventually overthrowing the dollar. But, even so, any change in the U.S. dollar’s strength certainly wouldn’t happen overnight. Despite calls for an alternative reserve currency, it’s still hard to imagine any country capable of taking the mantle from the U.S.as the global currency anytime soon.