The first US dollar, as it is known today, was printed in 1914 upon the creation of the Federal Reserve Bank. Ever since the Bretton Woods Agreement, in 1944, established that central banks would maintain fixed exchange rates between their currencies and the dollar and that the United States would redeem US dollars for gold on demand, the American dollar has been bossing the world.
According to the International Monetary Fund, the US dollar is the most popular currency in the world. As of the first quarter of 2020, it made up over 60% of all known central bank foreign currency reserves. The next closest reserve currency is the euro. It makes up 20% of known central bank foreign currency reserves. The other favoured currencies are UK pound sterling (GBP), Japanese yen (JPY) and Swiss franc (CHF).
More than 1.8 trillion dollars of US currency is in circulation around the globe and is widely recognised as the de-facto global currency, meaning that it is retained in reserves by most governments. Similarly, global corporations trust it for international trade.
While Covid-19 has dealt a whammy all over the world, causing lakhs of people to lose their jobs and sending currency values plummeting, the US dollar still stands tall and powerful. In fact, the US dollar has risen in value this year, gaining almost six percent from the low it reached in March, according to the US dollar index which measures the greenback’s value against a basket of other currencies.
This anomaly is due to the dollar’s privileged position as the world’s reserve currency. During uncertainty, investors all over the world flee to what is known as “safe havens”. That means, in times of crisis investors put their money in reserves of US currency, even if the US economy is struggling. Calling it “the exorbitant privilege of the dollar,” Kit Juckes, global head of foreign exchange strategy at Societe Generale, said, “Lots of people want dollars all the time.”
Unlike other currencies, the US Federal Reserve can print a lot of dollars without the dollar necessarily weakening. This is evident from the recent US Federal Reserve’s move to pump multiple and trillions of dollars into the financial system, which has not weakened the value of the currency.
In the foreign exchange market, the dollar rules. Around 90% of forex trading involves the US dollar. The dollar is just one of the world’s 185 currencies according to the International Standards Organization list, but most of these currencies are only used inside their own countries.
Almost 40% of the world’s debt is issued in dollars. As a result, foreign banks need a lot of dollars to conduct business. This became evident during the 2008 financial crisis. Non-American banks had $27 trillion in international liabilities denominated in foreign currencies. Of that, $18 trillion was in US dollars. The result was that the US Federal Reserve had to increase its dollar swap line. That was the only way to keep the world’s banks from running out of dollars.
Business owners worldwide understand in times of severe economic contraction, they will need significant capital reserves to stay afloat. Fearing a liquidity crunch, where the demand for cash significantly outstrips the supply, they snap up dollars while the getting is good. Businesses understand that deep US financial markets are key to weather difficult economic headwinds. They also appreciate the transparency of America’s fiscal policies. The dollar is more than simply the chief reserve currency; it is the currency that companies turn to in moments of crisis, a role it has played during majority of economic crises as it is doing now during this Covid-19 pandemic.
What else affirms the superiority of USD is that it hails from the world’s largest economy, the United States of America, which is known to be economically and politically a stable nation.
There is no denying the fact that the US dollar’s value doesn’t or will not fluctuate, but you are normally sure that it will probably not plunge like the Turkish lira or the Argentinian peso. The huge demand for US dollars can cause shortage during times of economic crisis. America’s central bank, the Federal Reserve, is responsible for issuing currency and taking extra measure to prevent a squeeze when there is a rush for the dollar. For example, during this ongoing pandemic, it set up a number of swap lines with other major central banks, making sure there is enough money available for investment and spending. This helps stabilisation of the currency markets when the desire for the US dollar surges.
Despite trillions of dollars in foreign debt and continuous large deficit spending, the United States still holds global trust and confidence of its ability to pay its obligations. For this reason, the US dollar remains the strongest world currency. It seems likely that it will continue to be the top global currency in the years to come.
The writer is a research scholar at IIT Roorkee. [email protected]