HOW THE US DOLLAR CAME TO BE THE GLOBAL CURRENCY

They say that money makes the world go around but let be more specific, its actually the US
dollar. For example, if you are a French wine exporter and you need Chilean oak for your wine
barrels, you pay in US dollars; if you are Brazilian coffeemaker and you want to sell your coffee
to make drinks in Turkey, you get paid in US dollars, such is the power of the dollar.

Since Russia’s invasion of Ukraine some time ago, the US response has been primarily
economic, other countries can impose sanctions and of cos many have but US sanctions are more
damaging. Acting on its own, the US can exact a huge amount of pain, the reason for that is all
about the dollar and the dollar’s very special status as the world’s reserve currency. It’s the main
currency used by multi-national businesses and financial institutions, that means when the US
imposes sanctions it has more power to mess up the workings of another countries central bank
and its global trade relations so where does that special privilege come from? We will be looking
at how the US dollar came to have so much power. Let’s start with the history of the dollar, shall
we?

History of the U.S. Dollar

According to Investopedia the first documented use of paper currency in the U.S. dates back to
1690 when colonial notes were issued by the Massachusetts Bay Colony. These notes were used
to fund military operations. It wasn't until 1776 that the first $2 bill was introduced nine days
before independence. Nine years later, in 1785, the U.S. officially adopted the dollar sign, using
the symbol for the Spanish American peso as a guide.

In 1863, the government established the Office of the Comptroller of the Currency (OCC) and
the National Currency Bureau. These two agencies were charged with handling new banknotes.
Centralized printing begins at the Bureau of Engraving and Printing in 1869. Prior to this, money
was printed by private companies.

The U.S. Treasury assumed the official responsibility of issuing the nation's legal tender in 1890
more than a decade before the creation of the Federal Reserve and the dollar as we know it
today.

The Gold Standard

The Federal Reserve Act of 1913 created the Federal Reserve Bank to respond to the
unreliability and instability of a currency system that was previously based on banknotes issued
by individual banks. This was the same time that the U.S. economy became the world’s largest,
surpassing that of the United Kingdom. World commerce still centered around the U.K., though,
as the majority of transactions took place in British pounds.

The majority of developed countries pegged their currencies to gold as a way to stabilize
currency exchanges. But when World War I broke out in 1914, many countries suspended their
use of the gold standard to pay their military expenses with paper money, which devalued their
currencies. Britain, though, held to the gold standard to maintain its position as the world’s
leading currency and found itself borrowing money for the first time during the third year of the
war.

The United States became the lender of choice for many countries that wanted to buy dollar-
denominated U.S. bonds. Britain finally abandoned the gold standard in 1931, which decimated
the bank accounts of international merchants who traded in pounds.

By then, the dollar replaced the pound as the leading international reserve currency.

What Was the Bretton Woods Agreement and System?

The Bretton Woods Agreement was negotiated in July 1944 by delegates from 44 countries at
the United Nations Monetary and Financial Conference held in Bretton Woods, New Hampshire.
Thus, the name “Bretton Woods Agreement.

Under the Bretton Woods System, gold was the basis for the U.S. dollar and other currencies
were pegged to the U.S. dollar’s value. The Bretton Woods System effectively came to an end in
the early 1970s when President Richard M. Nixon announced that the U.S. would no longer
exchange gold for U.S. currency.

The Bretton Woods Agreement and System Explained

Approximately 730 delegates representing 44 countries met in Bretton Woods in July 1944 with
the principal goals of creating an efficient foreign exchange system, preventing competitive
devaluations of currencies, and promoting international economic growth. The Bretton Woods
Agreement and System were central to these goals. The Bretton Woods Agreement also created
two important organizations—the International Monetary Fund (IMF) and the World Bank.
While the Bretton Woods System was dissolved in the 1970s, both the IMF and World Bank
have remained strong pillars for the exchange of international currencies.

Though the Bretton Woods conference itself took place over just three weeks, the preparations
for it had been going on for several years. The primary designers of the Bretton Woods System
were the famous British economist John Maynard Keynes and American Chief International
Economist of the U.S. Treasury Department Harry Dexter White. Keynes’ hope was to establish
a powerful global central bank to be called the Clearing Union and issue a new international
reserve currency called the bancor. White’s plan envisioned a more modest lending fund and a
greater role for the U.S. dollar, rather than the creation of a new currency. In the end, the adopted
plan took ideas from both, leaning more toward White’s plan.

It wasn't until 1958 that the Bretton Woods System became fully functional. Once implemented,
its provisions called for the U.S. dollar to be pegged to the value of gold. Moreover, all other
currencies in the system were then pegged to the U.S. dollar’s value. The exchange rate applied
at the time set the price of gold at $35 an ounce.

Benefits of Bretton Woods Currency Pegging

The Bretton Woods System included 44 countries. These countries were brought together to help
regulate and promote international trade across borders. As with the benefits of all currency
pegging regimes, currency pegs are expected to provide currency stabilization for trade of goods
and services as well as financing.

All of the countries in the Bretton Woods System agreed to a fixed peg against the U.S. dollar
with diversions of only 1% allowed. Countries were required to monitor and maintain their
currency pegs which they achieved primarily by using their currency to buy or sell U.S. dollars
as needed. The Bretton Woods System, therefore, minimized international currency exchange
rate volatility which helped international trade relations. More stability in foreign currency
exchange was also a factor for the successful support of loans and grants internationally from the
World Bank.

The IMF and World Bank

The Bretton Woods Agreement created two Bretton Woods Institutions, the IMF and the World
Bank. Formally introduced in December 1945 both institutions have withstood the test of time,
globally serving as important pillars for international capital financing and trade activities.

The purpose of the IMF was to monitor exchange rates and identify nations that needed global
monetary support. The World Bank, initially called the International Bank for Reconstruction
and Development, was established to manage funds available for providing assistance to
countries that had been physically and financially devastated by World War II.

In the twenty-first century, the IMF has 190 member countries and still continues to support
global monetary cooperation. Tandemly, the World Bank helps to promote these efforts through
its loans and grants to governments.

The Bretton Woods System’s Collapse

In 1971, concerned that the U.S. gold supply was no longer adequate to cover the number of
dollars in circulation, President Richard M. Nixon devalued the U.S. dollar relative to gold. After
a run on gold reserve, he declared a temporary suspension of the dollar’s convertibility into gold.

By 1973 the Bretton Woods System had collapsed. Countries were then free to choose any
exchange arrangement for their currency, except pegging its value to the price of gold. They
could, for example, link its value to another country's currency, or a basket of currencies, or
simply let it float freely and allow market forces to determine its value relative to other countries'
currencies.

The Bretton Woods Agreement remains a significant event in world financial history. The two
Bretton Woods Institutions it created in the International Monetary Fund and the World Bank
played an important part in helping to rebuild Europe in the aftermath of World War II.

Subsequently, both institutions have continued to maintain their founding goals while also
transitioning to serve global government interests in the modern-day

The U.S. Dollar Today

The dollar remains the world's reserve currency today. Central banks hold around 59% of their
reserves in U.S. dollars, according to the International Monetary Fund (IMF).

Many of the reserves are in cash or U.S bonds, such as U.S. Treasuries. Dollar-denominated debt
outside the U.S. continues to rise, with levels reaching $13.4 trillion as of mid-2022. The are
many countries that would relish the opportunity to occupy the enviable position of being the
world number one currency and many have tried but for now and the foreseeable future the US
dollar remains supreme.

There are always questions whether the U.S. dollar will lose its status as the world’s reserve
currency. Investors are concerned that the Federal Reserve’s easy monetary policy, combined
with rising budget deficits, will undermine confidence in the dollar. The recent drop in the dollar
over the past year has heightened these concerns. There can be unforeseen consequences from
the current policy mix, the dollar’s role as the dominant global currency looks secure.

The U.S. dollar is also used in about 40% of global trade and nearly 80% of all global cross-
border transactions. Most commodities and many other goods are traded in U.S. dollars—oil,
copper, and agricultural goods—to name a few. Investors need to hold dollars to trade in goods
and services, and need to have a large and liquid bond market to in which to invest those dollars.

What About Alternatives?

Over the years, the euro’s usage in global transactions has grown, the Japanese yen’s usage has
been largely stable, and there has been a slight increase in the renminbi’s role. However, none of
these currencies seem likely to supplant the dollar any time soon.

The most likely candidate would be the euro, as the euro area represents a large segment of
global gross domestic product. However, its bond markets are fragmented across many different
countries and are less liquid than the U.S. Treasury bond market, limiting the amount that a
foreign investor might be able to hold in euros.

China is believed to have ambitions to make its currency the pre-eminent reserve currency, but it
has a long way to go. The biggest limitation is that its currency’s value is managed. It isn’t freely
convertible to other currencies, so investors can’t be sure whether capital controls could be used
to limit access their holdings. So far, it has very limited usage in global transactions, representing
just 3% of global transactions relative to about 80% for the dollar.

Reserve Currencies Rise and Fall in Value

The dollar’s role as the world’s reserve currency will remain intact for the foreseeable future, its
value will rise and fall with changes in the economic fundamentals. Since its peak in March
2020, the dollar has dropped by about 11%. The decline reflects the Federal Reserve’s expansive
monetary policy when the COVID-19 crisis hit. The Fed lowered short-term interest rates and
increased the supply of dollars available to foreign central banks to help ease financial conditions
during the crisis. However, there is no concerted effort by the central bank to undermine the
dollar’s value. In fact, a weaker dollar is generally seen as a positive for global growth because it
eases financing conditions for borrowers—especially in emerging-market countries.

Finally, the dollar remains a safe-haven asset. During times of global stress, the dollar generally
moves up as investors seek a large, liquid, and reliable place to put their money. When the
pandemic struck in early 2020, the dollar soared to its highest level in decades compared to a
wide range of other currencies due to global demand.

Having the world’s reserve currency affords the U.S. some privileges. It means there is
underlying demand for U.S. bonds from foreign central banks and other large investors looking
for a safe market in which to invest. That allows the U.S. to borrow at lower rates than would
otherwise be possible. Many years ago, former French President Valéry Giscard d’Estaing used
the phrase “exorbitant privilege” to describe the benefits accruing to the U.S. from having the
world’s reserve currency. It’s still the case today.