It is not a surprise to anyone that the United States of America is the world's leading superpower; from its powerful military might to their dominant economy, it is safe to say that the US is one of the most powerful countries in the world. But how did they get there?
How did the US Dollar become the global currency? The goal? To fix the rate of exchange for all foreign currencies to the US dollar, where the United States would redeem any dollar for its value in gold. At the time, the United States was the only country largely unscathed by the war while the economies of other European countries had been severely battered. Thus, allowing other countries to back their currencies with dollars rather than gold.
The deficit spending that was used to finance the Vietnam War caused the United States to flood the market with paper money, thus depreciating the value of the dollar. However, rather than allowing investors to deplete Fort Knox United States Bullion Depository of all its gold reserves, President Nixon made the final decision to sever the tie of the US dollar to gold. This led to the floating exchange rates or fluctuating exchange rates that exist today, where the currency price of a nation is set by the forex market based on supply and demand relative to other currencies, a free-for-all if you will.
Of course, such drastic measures had led to dire consequences in the US such as stagflation , a terrifying combination of high inflation and high unemployment, and high oil prices. However, thanks to brilliant economists like Milton Friedman and Paul Volker who introduced various fiscal policies, they managed to overcome stagflation and allowed the US economy to recover.
After all, no king rules forever and other contenders for the world currency such as the Euro, Renminbi also known as Yuan or even the Russian Ruble might overtake the dollar.
But surprisingly, that is not the case. In , former chairman of the US Federal Reserve, Alan Greenspan, said the Euro could potentially replace the dollar as a world currency , and his words held some form of truth to it.
The EU consists of 27 countries as their members and is one of the world's largest economies , so are they the ones who would replace the almighty US dollar? Not exactly. The early days of the post-gold world were rough. At moments in the s, the value of the dollar fluctuated wildly, amid fears about rampant U. But since then, the U. More cross-border trade and financial flows are now settled in dollars than ever before.
And it remains by far the most popular currency for countries to stash their national savings. There are many theories why. The sheer size of the U. The dominance of U. Only the U. And the U. Switzerland, whose franc is often thought of as a junior reserve currency, is doing just that at the moment.
So the dollar became, and stayed, the default. More broadly, the dominance of the dollar also stems from those squishy, somewhat mystical elements of financial markets: Confidence and trust.
This is where economics blurs with philosophy and sociology. Perhaps some of the best thinking on these topics was done by George Simmel in his opus, the Philosophy of Money. In it, he posits that that the usage of money is, essentially, a mechanism of spreading trust throughout an ever-widening circle of anonymous individuals.
The last few years have seriously tested that trust in the U. Delegates from 44 Allied countries met in Bretton Wood, New Hampshire, in to come up with a system to manage foreign exchange that would not disadvantage any country. That's because the greenback was, itself, linked to gold. The arrangement came to be known as the Bretton Woods Agreement.
It established the authority of central banks , which would maintain fixed exchange rates between their currencies and the dollar. In turn, the United States would redeem U. Countries had some degree of control over currencies in situations wherein the values of their own currencies became too weak or too strong relative to the dollar. They could buy or sell their currency to regulate the money supply. Instead of gold reserves, other countries accumulated reserves of U. Needing a place to store their dollars, countries began buying U.
Treasury securities , which they considered to be a safe store of money. The demand for Treasury securities, coupled with the deficit spending needed to finance the Vietnam War and the Great Society domestic programs, caused the United States to flood the market with paper money.
With growing concerns over the stability of the dollar, the countries began to convert dollar reserves into gold. The demand for gold was such that President Richard Nixon was forced to intervene and de-link the dollar from gold, which led to the floating exchange rates that exist today.
Although there have been periods of stagflation , which is defined as high inflation and high unemployment, the U. The dollar remains the world's reserve currency today. Many of the reserves are in cash or U. S bonds , such as U. Dollar-denominated debt outside the U. Most people would believe that this makes the dollar the strongest currency in the world. Despite its position in the global markets and how dependent they are on it, the dollar ranked as the 10th strongest currency, according to CMC Markets.
The site ranked the Kuwaiti dinar as the strongest currency while the British pound and the euro earned the fifth and eighth spots respectively.
The reserve status is based largely on the size and strength of the U. Despite large deficit spending, trillions of dollars in debt, and the unbridled printing of U.
Treasury securities remain the safest way to store money. The trust and confidence that the world has in the ability of the United States to pay its debts keep the dollar as the most redeemable currency for facilitating world commerce. The history of paper currency in the United States dates back to colonial times when banknotes were used to fund military operations. This was a year after the Federal Reserve Act was established.
The decision was made by a delegation from 44 Allied countries called the Bretton Woods Agreement. There are a series of alternatives that could replace the dollar as the next global reserve currency.
The euro is the most used reserve after the dollar and could replace the dollar if economic conditions move in its favor. China's renminbi could surpass the dollar, a goal that the country's leaders are keen on realizing. The world's developed countries met at Bretton Woods, New Hampshire, to peg the exchange rate for all currencies to the U.
At that time, the United States held the largest gold reserves. This agreement allowed other countries to back their currencies with dollars rather than gold. By the early s, countries began demanding gold for the dollars they held. They needed to combat inflation. Rather than allow Fort Knox to be depleted of all its reserves, President Nixon separated the dollar from gold. By that time, the dollar had already become the world's dominant reserve currency.
But, unpegging the dollar from its value in gold created stagflation. That's a combination of inflation and stagnant growth. In March , China and Russia called for a new global currency.
China was concerned that the trillions it holds in dollars would be worthless if dollar inflation set in. This could happen as a result of increased U.
Treasurys to support U. In the fourth quarter of , the Chinese renminbi became another one of the world's reserve currencies. China wants its currency to be fully traded on the global foreign exchange markets. It would like the yuan to replace the dollar as the global currency.
To do so, China is reforming its economy. Despite trillions of dollars in foreign debt and continuous large deficit spending, the United States still holds global trust and confidence in its ability to pay its obligations.
For this reason, the U. It may continue to be the top global currency in the years to come. Countries such as China and Russia feel a new one-world currency, one not backed by any one nation, is overdue in this increasingly integrated global economy. International Money Fund. Currency Education Program. Currency in Circulation. International Monetary Fund. Federal Reserve Bank of New York.
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