Everyone knows that the dollar is a global currency. However, not everyone understands what this means and why it happened..
Global currency — the currency in which most of the international settlements, commercial and financial. Another name for the global currency — backup. It is believed that there are three global currencies: the dollar, the euro and the yen.. Dollar — leader of reserve currencies.
The dollar has not always been the leader in world currencies. The main impetus for this was the signing in 1944 of the Bretton Woods Agreement, according to which the United States, Western Europe, Canada, Australia and Japan actually established a new mechanism for regulating the international financial system. Until 1944, national currencies were pegged to gold. Now they have become attached to the dollar. Only the dollar remained tied to gold. Gold price was fixed at $ 35 per ounce. The main goal of the Bretton Woods Treaty was to replace the poorly performing gold standard after the Great Depression, according to which all major currencies were freely exchanged for gold. Pegging currencies to the dollar was supposed to make the international system more flexible and stable, especially during economic downturns..
The central banks of the participating countries pledged to maintain a stable exchange rate against the US currency through foreign exchange interventions, avoiding deviations by more than 1%. To support the operation of the new system, the International Monetary Fund (IMF) was created, which provided loans to support national currencies, and the International Bank for Reconstruction and Development (IBRD).
Benefits of the United States after the conclusion of the Bretton Woods agreements
- During and after World War II, the US economy did not suffer as much as the economies of its European allies. This enabled the United States to export its goods to Europe and receive gold for them as payment. As a result, more than 2/3 of the world’s gold reserves are concentrated in the United States..
- The dollar became the only currency tied to gold, increasing its value as a single exchange equivalent.
- The United States was able to pursue favorable financial and trade policies for its economy and easily survive the emerging balance of payments deficit.
- Thanks to the influence of the IMF, the United States was able to influence the international financial system and politics. The decision on loans issued by the IMF to support the economies of certain countries often had a political basis.
- The United States began to play the role of the world central bank, issuing loans in its own currency to countries in need and receiving interest for this in the form of goods entering the country. Of the $ 580 billion issued in circulation, 65% circulate outside the country.
Abandoning the dollar gold standard
By the 1970s, it was increasingly difficult for the United States to maintain equality between banknotes issued and the size of the gold reserve. Aware of the growing external debt of the United States, many countries began to demand to exchange their dollars for gold. The Vietnam War required increasing costs, which were covered, among other things, with the help of a printing press. Military needs were met by increasing imports, which led to an increase in the trade deficit. The country was under the threat of depletion of the gold reserve. The situation was resolved by President Nixon. He announced the rejection of the dollar peg to gold.
In 1971, the Smithsonian Agreement was signed, according to which the participating countries pledged to maintain fixed exchange rates against the dollar, but the dollar was not pegged to gold. The gold-dollar standard was replaced by the paper-dollar standard. In addition, the United States did not commit itself to maintaining a stable exchange rate and controlling the magnitude of inflation and trade deficits. All this led to a rapid rise in gold prices (from $ 38 to $ 215 per ounce) and to a landslide fall in the dollar. European countries stopped buying it, not wanting to maintain an overvalued exchange rate.
Why the US dollar is the king of currencies
In 1973, the fixed exchange rate of national currencies against the dollar was replaced by a floating one. The dollar continued to decline, which was beneficial to its exporters and did not meet with resistance within the United States..
The depreciation of the exchange rate made it possible to remove the balance of payments deficit and reduce inflation. Cheap goods from the USA flooded the international markets. At the same time, inflation rose within the country due to the increasing cost of imported goods..
Why the dollar is the # 1 currency today
- It is believed that the dollar’s leadership is associated with such mystical characteristics of financial markets as trust and reliability. It is the belief in the economic power of the United States that drives people to invest in dollars. No wonder, according to Georg Simmel, German philosopher and sociologist, «the use of money is, in fact, a mechanism for spreading trust in an increasingly expanding circle of people».
- The US GDP accounts for nearly a quarter of world GDP. The scale of a country’s economic activity determines the importance of its currency.
- More than 1/3 of world GDP comes from countries that peg their currencies to the dollar.
- After the war, most developed countries had positive trade surpluses. They exported more than they imported. Since settlements were made in dollars, many countries had accumulated large dollar reserves that had to be invested somewhere. The post-war European economy was not stable, and the only place where money could be invested without much risk was US government treasuries. So European countries began to lend to the American economy at a fairly low interest rate. This process continues now.
- Only the United States has financial markets with such a degree of freedom and openness that allows you to work with any amounts and players with any internal control mechanisms.
- The United States, unlike, for example, Japan or Germany, does not try to protect its exporters by making efforts to reduce the volume of dollar transactions..
- The dollar is the main currency in the international exchange market. It is used in over 85% of all forex transactions. About 40% of international loans are denominated in dollars, so the banks issuing loans are constantly in need of them. For example, in the 2008 crisis year, non-American banks issued loans in the amount of $ 27 trillion, of which $ 18 trillion were in them and nominated.
- The dollar is the most common currency used by central banks to build reserves. It accounts for over 60% of the foreign exchange reserves of all central banks in the world. For comparison, Euro — about 20%.
In 2009, China and Russia recalled the distant year 1944, when Keynes, who represented the interests of Great Britain, tried to convince the participants to create a new world currency at a conference in Bretton Woods. As well as then, in 2009 this proposal did not meet with enthusiasm. Despite numerous attempts to put an end to the dollar as world money, it still performs well the necessary functions. It is liquid, stable and safe. The world is not ready to give it up. The global financial system based on the dollar will certainly transform someday, but it is clear that this time has not yet come..