Have you ever wondered that why Dollar is considered as a global currency and why not others? Or how has Dollar emerged as the leader in the world over other nations? Still wondering…but no more. Let’s look into the facts and the rationale behind the use of dollar everywhere.
In 1914, Britain was the most powerful economy in the world and the Pound Sterling was the accepted global reserve currency used by everyone. Around this time, most countries had adopted the Gold Standard. Under this system, countries agreed to convert their paper money into a fixed amount of gold whenever a nation would demand it. This helped boost international trade and set exchange rates. For instances, if Britain guaranteed an ounce of their gold in return for 20 pounds, while the USA guaranteed to give up an ounce of theirs for 30 dollars, then one could conclude that 1 Pound Sterling was equal to 1.5 USD.
It made international trade simple and British investors poured money into foreign investment, protected by a strong currency and the might of the British Empire. But you need to put money, a lot of it, to fund a war.
The First World War broke out in 1914 and Britain suspended the gold standard. Britain was leading Allied war efforts against the Central powers and was spending a lot.
The war proved too costly, and in spite of emerging victorious, the sun had begun to set on the once mighty British Empire. For around 100 years before the First World War, the Americans had failed to develop a stable currency, after nearly a dozen versions were wiped out due to a series of financial crises. But by 1917 the US had overtaken Britain thanks to strong exports. The Federal Reserve Bank, formed in 1914, was in charge of issuing Dollar banknotes which lent extensively to the allies in support of the war efforts. The Pound Sterling was battered after the war and when Churchill returned to the Gold Standards in 1925, at the old exchange rate of $4.86 to the pound, but this was an inflated value, more than 10% of what it should have been.
The 30s was an era of protectionism and mistrust, with very limited international trade. Most countries had done away with the Gold Standard by this time and a Second War broke out in 1939. Inflation was at all-time high due to excessive printing of banknotes once again. It is even believed that Nazis printed over 500,000 counterfeit Pound Sterling bank notes every month. Consider a small nation producing only a 100 ships prices at $1 million each with $ 100 million of currency in circulation.
But also consider that the nation’s government has decided to double its currency printing to 200 million dollars without increasing the ship production. The additional $100 million in the system doesn’t necessary means economic prosperity. It would mean that it would lead to inflation. On the other hand, if the currency printing is halved keeping the ship production constant, it would lead to deflation with a fall in the ships price. The amount of currency printing needs to be in sync with the goods or services that are produced in the economy. Too much inflation and deflation are undesirable. Towards the end of the 2 nd World War in 1944, nations suffered from excessive inflation and economic losses.
Apart from war time spending, most countries were in shambles and needed to be rebuilt. To plan the same, the US and 43 other Allied nations met at Bretton Woods New Hampshire. With no nation with enough gold reserves to print currency against, the conference established the Gold Exchange Standard in which each nation would peg it’s currency to the dollar and the US would peg the dollar to Gold.
The US vowed to keep the printing of dollars limited and promised to redeem dollar for gold on demand at 35 dollars at ounce. The Bretton Woods Arrangements, while sealing the long impending of the pound hegemony, crowned the US dollar as the new global reserve currency.
Consider a trading nation, if it exports more than it imports, it’s a trade surplus nation. The trade surplus needs to be invested or stored. The currency in which it is stored is called the reserve currency. There are few factors that made this possible – The US was capable of taking huge financial investment due their large and liquid markets. They were willing to run a current account deficit and above all, countries had confidence and trust in them. The dollar has the preferred invoicing currency between non – US nations. Take for instance a country like Brazil, it would buy Indian made cars but would pay for them in dollar instead of rupees.
The dollar is also a funding currency, meaning any loan or debt given out is in dollars. During the Vietnam War in the 50s or 60s, the Gold reserves started depleting as it was now printing excess currency. This led to overvaluation of dollars. The central banks of other nations were now sceptical about the ability of the US.
In August 1971, the French even sent a warship to New York to bring back their gold held against the US dollar reserves. With mounting pressure Richard Nixon went in to shock the world as he declared that the United States dollar would now be a Fiat money, and that it would not convert any dollars to Gold anymore. As global mistrust grew after the event, the US economy suffered. But with the growing demand for energy the world over, and oil being priced in dollars, the currency continued to be in demand.
The lowest that the Dollar share in the world reserves has even been was 46% in 1991. And continuous international efforts to undermine the dollar has failed till date. The Euro, a common currency to be used by European nations for trade was introduced to offset the dollars growing rise but the crises of 2008 slowed down the dream. As of March 2018, the United States Dollar forms nearly 63% of all global reserves, followed by the Euro at 20.39%, the Yen at 4.86% and the China yuan at just 1.39%. Investors still considered the dollar as a safe bet.
Despite China being the world’s second largest economy and having the largest trade surplus over the US, the global central banks are still not convinced and not confident of keeping Yuan as Dollar‘s successor. The reign of the dollar as the global reserve currency is expected to continue unless a worthy challenger stakes claim.
But if you look at the history of the world, reserve currency status doesn’t last forever.And it might become true if the policies and strategies taken by Trump don’t get rectified sooner. Where US on one side has adopted American First Policy while China has started to expand its roots to different nations through its strategic decisions which may induce other nations to accept Yuan as the global currency. Only the future will tell us if Yuan is able to succeed the Dollar, become the global currency and then rule the entire world with it just like Americans have been doing from past 100 years.