Tough times call for smart decisions, like liquidating assets and storing some U.S. dollars when economic times are uncertain. While local currencies are bound to reduce in value, many believe the U.S. dollar will remain steady amidst financial turmoil.
Therefore, it comes as no surprise that nearly 80% of all 100-dollar-bills are scattered all over the world. This goes to show how much faith people have in the U.S. dollar, recognized globally as the de facto world currency.
How come the U.S. dollar is so popular?
Even before delving into the details of the steady value of the U.S. dollar and reason why U.S. dollar is the highest currency in the world, the popularity of the currency is simply stupefying. Apart from financially savvy folks hiding some dollars under their beds to keep afloat when things hit the fan, governments too are not left behind! They may not necessarily stuff thousands of 100-dollar bills in their mattresses, but they have been known to pile up loads of T-bills and U.S. Treasury bonds, all of which are valued in U.S. dollars. The U.S. dollar has, therefore, rightfully earned the title’ reserve currency.’
What is a Reserve Currency?
It is a foreign currency held in large amounts by global central banks and other financial institutions as part of their foreign exchange reserves. The currency is used in many forms of international trade, investments, and other international transactions. Simply put, it is a global currency accepted for all forms of monetary transactions throughout the world. Other currencies used include the Japanese Yen and the Euro, but nothing comes close to the U.S. dollar.
It boasts an astounding 60% of all foreign exchange reserve currencies held by banks worldwide, with the Euro coming second at only 20%. These are legitimate statistics provided by the International Monetary Fund in 2019. A difference margin of a whole 40% from the first to second is impressive. Let’s look at the history of the U.S. dollar to understand how it became this popular.
The Making of the U.S. Dollar
As a result of instability and the fragility of the currency economy, the Federal Reserve Act of the United States created the Federal Reserve Bank in 1913. This was a response to the unreliability of banknotes given by individual banks. At this time, the U.S. economy was thriving, though the British economy still dominated the majority of the global transactions. For this reason, the British pound was considered the dominant currency.
People did not fail to recognize the fragility of paper money. With this in mind, many still opted to keep their wealth in the form of gold, other than either of the two currencies. Things were good, up till 1914, when the First World War broke out. Gold became an insane way of transacting since it could not easily be divided into small parts. This made currencies the dominant way of transacting, and as people paid for their military expenses, their currencies lost value.
Since Britain has steadfastly held on to the value of gold, they were over passed by the U.S., and at some point, had to catch up. Having little money, they had to borrow money to stay afloat. The majority of countries turned to the U.S., which made the U.S. dollar the leading reserve currency. When World War II broke out, the nation found itself at yet another advantage.
It served as the main holder of supplies, goods, and weapons, and since gold was still used for payment, it found itself holding the majority of the world’s gold. This prevented a return of the use of gold in transacting since most countries had depleted their reserves. In 1944, allied countries met to discuss the way forward, to avoid putting other countries at a disadvantage, now that there was barely any gold for them.
A final decision known as the Bretton Woods Agreement was established, whereby neither currency would be linked to gold, but instead should have been linked to the U.S. dollar, which was then linked gold. Foreign Currency Exchange rates were now compared against the U.S. dollar, and in exchange, the gold held by the U.S. would be redeemed on demand. This gave local currencies the power to regulate their money supply, therefore determine its value against the U.S. dollar.
Becoming a Stand-Alone World Reserve Currency
As a result of the agreement, many banks accumulated U.S. dollar reserves and even purchased U.S. treasury treaties as security. This led to the flooding of the global economy with U.S. dollars, and concerns about the currency’s stability became widespread, and gold began to gain popularity as the preferred reserve. It led to the U.S. dollar’s delinking from gold, which resulted in the floating exchange rates that exist today. Even with unemployment and inflation, however, it has managed to stand as the world’s highest currency.
The majority of the world reserves are still in U.S. dollars, but a large proportion of the world’s debt is also denominated in dollars. It seems the popularity of the U.S. dollar, which happened by chance, is here to stay!