On June 6, 2023, the US dollar celebrated its 238th anniversary. For over 150 years, it has been an uninteresting local currency, except for residents of the British colony in the New World. However, in the middle of the 20th century, its “star hour” came, and it became the unwavering hegemon of the financial system. How did the dollar become the world’s currency?What are its prospects in that role?And can it have a worthy rival?
The Rise of the Dollar
To understand the rise of the American dollar, it is not necessary to delve too deeply into its origins. Instead, it is sufficient to recall the events that took place in the world during the 20th century.
Before Bretton Woods
The British pound was the dominant currency in the global financial system, with the “Empire that never sets” (Britain) retaining its position as the world leader in trade and economic activity. At the time, more than half the world used the pound to conduct international transactions, while the US had not yet established a central banking system.
The war significantly altered the situation. Major European powers became active participants in the conflict. To wage war, they needed, as Napoleon III said, money, money and more money. However, none of the participants had unlimited sources of funding, and the amount of printed currency was limited by the gold reserves of the countries.
Money could be obtained in the form of loans. However, the only real source of such loans was the United States. This country did not participate in the war actively, and in terms of industrial development, it was on par with European countries. Its banks enjoyed a reputation as reliable financial institutions in the world.
The warring parties used transoceanic loans to buy weapons from the United States, which was also a source of income for the country. Additionally, many companies and wealthy Europeans preferred keeping their capital in American banks, away from the conflict. As a result, the country became one of the leaders in the world economy after World War I. It accumulated almost half of the gold reserves in the world.
The Bretton Woods System
In July 1944, at a conference held at the Bretton Woods resort in the United States, a proposed system for organizing monetary relations was adopted. Despite resistance from the previous financial hegemon, Great Britain, the US proposals seemed quite logical and were accepted.
- The world received a universal global currency – the US dollar.
- Its stability was ensured through a fixed peg to gold at $35 per ounce.
- Exchange rates for participating countries were set in relation to the key currency.
- Central banks were required to keep exchange rate deviations within 1% via currency interventions.
This marked the beginning of dollar hegemony in the world, which still continues to this day.
From Bretton Woods to Jamaica
After the end of World War II, the economic recovery of countries, particularly Germany, France and Japan, progressed at a relatively rapid pace. The increased production and improved quality of goods resulted in a decrease in the demand for US-made products and, subsequently, the value of the US dollar. Furthermore, the new global power sought to strengthen its position by using a familiar tool – currency. Consequently, the amount of dollars issued increased, while the reserves of gold, which were supposed to guarantee its stability, remained largely unchanged.This led to a weakening of the fundamental principles of the Bretton Woods agreement, resulting in a decline in the real value of the US currency. The turning point occurred in the mid 1960s, when the amount of dollars in circulation began to exceed the gold reserves. This situation did not meet with the approval of the governments of participating countries.
France was the first to take action, unilaterally reverting to the gold standard in 1965. In response, France withdrew its gold reserves from the US, replacing them with ships loaded with dollars. This example proved to be contagious, with other countries following suit in just a few years. As a result, the amount of gold held by the Federal Reserve halved in just a short period of time.
In 1971, the then-US President, Richard Nixon, abandoned the gold backing of the dollar. Essentially, the US refused to exchange paper money for physical gold (which would have otherwise been tantamount to a default).However, by this time, over 50% of global trade transactions were conducted in dollars. As a result, countries preferred to maintain the US dollar’s status as the primary currency, rather than risk a severe economic crisis. This situation was officially consolidated in 1976 at an international financial forum held in Jamaica.
The main outcome of this meeting was the elimination of fixed exchange rates and the establishment of a free-floating currency market. Today, this system continues to govern global financial transactions.
Why the Dollar Maintains Stability Today
Despite all the events in global politics, economics and the financial system, the US dollar continues to maintain stability as the world’s universal means of payment and as the primary reserve currency. It seems that it will not lose this status in the foreseeable future. The main reason for this is the almost religious belief in the economic superiority of the US over the rest of the world, which accounts for almost 25% of global GDP. This is supported by the operation of market-based economic laws, protection from US government institutions such as the Federal Reserve and judiciary, and the high reliability of US Treasury securities as the main tool for global expansion.This belief is shared by the largest participants in the global financial system: central banks. Many of these central banks persistently hold their reserves in dollars, more specifically in US Treasury securities. Although, in light of recent events, the role of the dollar as a reserve currency has diminished somewhat (it has lost nearly 10 percent in global reserves), it nevertheless maintains a leading position with a share that continues to be unreachable by others at 59 percent. Furthermore, the dollar benefits from the world’s largest volume of US exports and imports. Settlements for these transactions constitute a significant portion of all global transactions, with nearly 50 percent of global trade conducted in dollars.