How did the US Dollar become the most important currency of the world? - March 18, 2018
The US dollar is the most important currency of the world. It’s the reserve currency for most countries, and it’s also a popular choice for individual investors to keep their wealth in. How did the dollar become what it is today and what does the future hold?
The US dollar is the main reserve currency of the world. It’s the most important currency in international trade. It’s also an important currency for central banks which keep a part of their foreign reserves in it. It’s important for professional and individual investors alike. There are some historical and economic reasons behind this success.
When pound was in dollar’s place
Not that long ago, the British pound was the main reserve currency of the world. This was the case from the 1820s until the beginning of the 1900s. In that time, London was the undisputed centre of world finance. Although, the US economy outgrew Britain’s in the 19th century, pound remained the leader. Until 1914, there wasn’t even a US dollar printed by the Fed as we know it today.
But to take over the title of the reserve currency of the world, the US dollar needed something shocking: World War I. Since the US entered the war long after its allies, it was in a much better shape. In the meanwhile, Britain had serious problems and was unable to help its allies. What’s more, it had to start borrowing money from the US. This was the first step in giving up their domination.
Bretton Woods made it final
The World War II strengthened the US’ position again. Since they entered the war late once more, they were able to help their allies. But this came with a price: US exports were paid by the gold of those countries. In the end, the United States owned a huge amount of the world’s gold, which was a key element in the success of the dollar.
In time of (past) wars, countries often disconnect their currencies of gold, to make it worth more. This way, they were able to print money as they wished; therefore, they could afford their war efforts. After the war, currencies were often based again on gold, but this time that wasn’t possible. The US had the gold, but others didn’t have enough to back their money with it. Hence, Allies based their currencies on the US dollar, and the dollar itself was based on gold. This was part of the agreement in Bretton Woods, which officially made the US dollar the most important reserve currency of the time.
The world changed, the dollar didn’t
Since then, many things changed, but the US dollar still holds its place as the main reserve currency. For economic reasons (having huge trade surpluses), most countries started to buy US Treasury securities. This meant that they basically lent money to the US. When the 70s came, the US deficits and foreign debts were already enormous. Theoretically, the US must have been able to convert any dollar debts to gold, but foreign lenders started to worry that they didn’t have enough gold to do that. This was indeed a valid fear, but then came Richard Nixon. The president broke the link between the dollar and the gold.
After this decision, the dollar had a rough period with fast changes in its price. But after a while, everything settled, and the US dollar kept its place. Although it’s not gold anymore, there are reasons why the dollar is what it is. The US is still the biggest economy of the world and it is also stable. Moreover, the dollar has high convertibility and the financial system behind it is open and free. This makes it for a perfect candidate to be a reserve currency. And there is one more thing: although the US dollar has many problems, people still trust it, and that is a huge strength.
Disclaimer: This analysis is for general information and is not a recommendation to sell or buy any instrument. Since every investment holds some risk, our main business policy is based on diversification to minimize threats and maximize profits. Innovative Securities’ Profit Max has a diversified portfolio, which contains liquid instruments. This way, our clients can maintain liquidity, while achieving their personal investment goals on the long term.