The dollar is the official currency of the United States and its surrounding regions, and it also serves as the official money of certain other countries. In fact, the U.S. dollar is frequently considered the world’s reserve currency. More than $1.8 trillion of U.S. currency is already in circulation worldwide, with two-thirds of $100 notes and nearly half of $50 notes likely to be held outside the U.S. As a matter of fact, the U.S. dollar is the de facto global currency, which means it is held in reserves by many governments, and that, most people and businesses trust it for international trade. Even as the coronavirus outbreak wreaked havoc on global markets, wiping off trillions of dollars in assets, the U.S. dollar remained untouched. It rose 4% versus a basket of major currencies at one time, including the euro, pound, yen, Canadian dollar, Swiss franc, and Swedish krona.
What caused this increase in the value of the U.S. dollar?
On December 19, 2019, Steven Mnuchin, the United States Secretary of Treasury, stated that “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.” Investors getting away to “safe havens” in times of unpredictability, referring to investments that are expected to hold their value during market instability. And, certainly, the U.S. currency is regarded as such. But why is this so? It comes from the world’s greatest economy, the United States, which is politically and economically stable in general. As we can be certain that the value of the U.S. dollar will vary, it is unlikely to fall as precipitously as the Turkish Lira or the Argentine Peso.
All of that demand for the dollar can lead to shortages during times of economic crisis, which exacerbates the problem. The Federal Reserve, America’s central bank, is in charge of creating money and goes to great lengths to avoid a squeeze when there is a rush for the greenback. During the financial and coronavirus crises, for example, it established a number of ‘ swap channels’ with other major central banks to ensure there is adequate money available for investment and spending. When demand for the U.S. dollar rises, this helps to stabilize the currency markets.
How did the U.S. dollar become the world’s primary reserve currency?
Well, for a long time, industrialized economies’ currencies were linked to gold. During World War I, however, many of these countries abandoned the gold standard and began paying their military expenses with paper money instead. The U.S. dollar, which was still pegged to gold, eventually surpassed the British pound to become the world’s top reserve currency. During World War II, the United States sold weapons and supplies to several of its allies and was paid in gold. By 1947, the United States had amassed 70% of the world’s gold reserves, putting other countries at a significant disadvantage. The 44 Allied countries convened in Bretton Woods, New Hampshire, in 1944 to try to resolve this and other financial issues. They concluded there that the world’s currencies would be anchored to the U.S. dollar, which would thereafter be linked to gold. As central banks began to accumulate reserves, these dollars were redeemed for gold, reducing the U.S. stockpile and raising concerns about the U.S. dollar’s stability. President Richard Nixon of the United States shocked the world in 1971 when he de-linked the dollar from gold. From there, floating exchange rates emerged, implying that exchange rates were no longer bound to gold and were set by market forces instead.
Despite market volatility and subsequent inflation, the U.S. dollar continues to be the world’s reserve currency. Because of their vast volume and America’s efficient banking system, the notes were more convenient and less expensive to exchange than other currencies. Today, the vast bulk of foreign exchange transactions are conducted in U.S. dollars, with no other currency coming close. In recent decades, the United States has even been suspected of “weaponizing” its money in order to gain strategic and geopolitical advantage. Critics referenced the Trump administration’s restrictions on North Korea and Iran, which included prohibiting them from using the dollar in trade. Some economies rely sorely on U.S. currency, which is frequently utilized in day-to-day transactions. In Cambodia, ATMs allow us to withdraw money in U.S. dollars. Commodities such as metals, energy, and agricultural items are typically exchanged in U.S. dollars on a global basis.
Here’s an illustration of how the U.S. dollar affects ordinary business transactions. Let’s assume an Indonesian coffee factory wishes to sell its products to a Turkish department store. If the Turkish shop attempts to pay in Turkish Lira, the Indonesian coffee farmer is likely to respond, “I have no idea how much this is worth, and I obviously won’t be able to use it in Indonesia.” Meanwhile, the department store might claim that the rupiah isn’t worth anything too in Turkey. As a result, they’re both more likely to transact in U.S. dollars. These dollars will subsequently be converted into Indonesian rupiahs. Once we add up the number of transactions as such that occur every day, you’re sending a lot of money into foreign economies.
Is There Any Chance for an Alternative Reserve Currency?
We have established that the U.S. dollar is financially secure. But we might be wondering, what about other currencies that are stable too like the Swiss Franc or the Singapore dollar, both of which come from politically and economically stable countries too. Well, those are fair points, but 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. According to the central banks’ foreign exchange reserves worldwide cited from the International Monetary Fund’s report on Q4 of 2019, the majority of currency reserves are 60,9% made up of U.S. dollars, the euro makes up nearly 21%, the Japanese yen makes up nearly 6% while the pound sterling makes up nearly 5%. Thus, could any of these other currencies give the dollar a run for its money?
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 threat of the U.S. sanctions or the “weaponized dollar” 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.” Some are hoping the world’s future reserve currency won’t be tied to a national government at all. They believe that cryptocurrencies like Bitcoin will eventually dethrone the dollar. Even yet, any change in the strength of the U.S. dollar is unlikely to occur overnight. Despite plans for an alternative reserve currency, it’s still difficult to imagine any country ever succeeding the United States as the world’s reserve currency anytime soon.
