The US Dollar: Why It’s the Reserve Currency of the World

The US dollar has come a long way since its introduction in 1792. Over time, it evolved into the world’s reserve currency, holding the highest level of confidence and liquidity, surpassing all other currencies in circulation.

In times of geopolitical turmoil, and a lack of trust in other monetary systems, the US dollar becomes the currency of choice of foreigners and foreign institutions that convert and park their money in US dollars. The currency closely associated with the history of a nation that became the dominant power of the world. This power is eminently represented in the trust in the US dollar.

There are 20 countries using a currency called ‘dollar.’ However, the US’ economic dominance eclipses the visibility of all other dollar denominations in circulation.

The foreign exchange, called ‘FX’ or ‘forex,’ is the marketplace where countries from around the world exchange currencies. It is the largest market in terms of trading volume, surpassing the credit markets and the trade of goods and services. About half of the approximately $5 trillion of transactions that are settled daily are denominated in US dollars.

It is estimated that approximately 70% of the physical paper dollars in circulation are held outside the United States, mostly in$100notes.

What helped make the US dollar the reserve currency is exemplified by the fact that a dollar issued in the 1860s is still a legal tender today, unlike the fate of many other currencies.

The 1960s saw a substantial increase of US dollars held in Eu- rope and elsewhere around the world. The expansion of these financial obligations put constraints on the dollar. As a result, on August 15th, 1971, the US unilaterally abandoned its commitment to the Breton Woods Accord that had been in place since 1944. The end of the agreement resulted in the suspension of the dollar’s convertibility into gold, replacing the gold standard with the dollar standard.

The value of the dollar was left to rise and fall according to market demand, the health of the US economy, and the confidence in the capital’s economic policy. The Breton Woods Accord inaugurated the dollar as a reserve currency of the world. Its cancellation de facto expanded its use.

Because the dollar was no longer backed by a physical and quantifiable precious metal like gold, the currency fluctuated wildly, creating uncertainty and inflation. This affected the price of imported items that were essential to the US economy, especially oil. The end of the accord contributed to the ‘oil shock’ of the early seventies.

As a result, the price of oil quadrupled in 1973. In order to remedy currency volatility, an agreement was made with Saudi Arabia, the leader of OPEC, to peg the price of oil to the dollar. In return, these countries would benefit from a strong economy and use their dollars to purchase bonds, stocks, real-estate, and military weapons.

The term ‘petrodollar’ was coined to reflect the agreement be- tween oil producing countries and the US. What the deal means is that in order for any country to purchase oil from OPEC, they first need to purchase dollars, honoring the dollar as the reserve currency of the world.

The same could be said about the price of gold being denominated in US dollars.

Federal Reserve Notes, are commonly known as money: Amedium of exchange that guarantees the fulfillment of a transaction. Its value is generated by confidence in the government and its institutions to manage the economy in a trustworthy and competent manner. These institutions would not exist without the underlying reality that a currency is backed by the total productive capacity of its people.

There are approximately 30 million small businesses in the United States. They hire close to 60 million workers. A small business is defined as a businesses with fewer that 500 employees. To be fair, the total number small businesses includes individuals that are independent contractors, also referred as self-employed. Overall, these businesses account for 97% of all economic activity in the US.

Communities across the nation rely on individuals and small businesses for production of jobs, goods, services and the general economic well-being of the population. The the sum production of all goods and services generated by the US workforce is defined as Gross Domestic Product (GDP). It creates revenues and profits that is taxable income levied by various levels of government, who in turn distributes the money for public works, services, social benefits and the defense industry.

The total productive capacity of Americans is generated by entrepreneurial spirit and all types of of labor, beginning with the settlers and all other immigrants that followed who came from varied parts of the world to the US to benefit from, and contribute to, the economy. They enabled the creation of a global network of contacts that favored global trade and economic growth.

As Alexis de Tocqueville observed during his journey in the country, Americans are not concerned by lofty ideals of virtue or righteousness. They are driven by self-interests, profits and wealth, principles that underline the American Way of life.

America’s entrepreneurial spirit produced the US’ dominant role in the world economy. It is secured by its military power and the global reach of Corporate America. And is responsible for US’ dollar status as the reserve currency of the world.

The strength of the US dollar will inevitably cause dislocations to other currencies and the world economy. When this happens, a reassessment about its role as a reserve currency will likely occur, and a new era in the global economy will unfold.

Read more about the symbols on US Dollar here.