For many years now, the U.S. dollar has been located in the fore of the global economic system, thereby modifying trade, finance, and investment. The dollar’s “reserve currency” status, as it is called, is viewed as the widely discussed issue that essentially impacts world economies, businesses, and governments. The reasons why the U.S. dollar remains predominant are still closely related to its superior capabilities, past glories, and the decisions made by both the USA and international organizations which are the derivatives of the main concepts.
Historical Context of U.S. Dollar Dominance
The origin of the U.S. dollar’s dominance can be found in the Bretton Woods Agreement of 1944 that took place at a time when the world was still recovering from the aftermath of WWII. A new system with fixed exchange rates was introduced and the US dollar was pegged to gold at $35 per ounce. Consequently, other currencies were pegged to the US dollar which in itself was the only non-reserve currency.
By the 1970s, the breaking point of the Bretton Woods system was reached when President Richard Nixon stopped the conversion of the dollar to gold. Nonetheless, the dollar still served as the most used means of exchange in the world. The strong US economy and highly developed US financial markets along with President Nixon’s decision to desist from backing the currency with gold effectively ensured the continued dominance of the dollar.
Global Trade and the Dollar
The U.S. dollar is still leading global trade, not only but definitely to a large extent due to reasons such as it being picked as the number one favorite money for international fund transfers. Apart from the fact that other markets have come into being and are also making use of fresh notes, the US dollar is the leading currency in worldwide trade.
What the situation is in the market now is that oil, which is the most traded commodity, is labelled and handled in U.S. dollars. That is also what “petrodollar” is about and it prescribes countries that need oil to keep their U.S. dollar reserves intact. The system has not only kept the demand for the U.S. dollar, i.e., the United States’ own currency, high as it also concordantly established the latter as the prevailing currency worldwide.
Role of the Dollar in Financial Markets
The U.S. dollar’s role doesn’t encompass only trade, but the higher level of use of the dollar is more in the sphere of finance. In the financial markets, the currency is constantly utilized for the purpose of investment, credit, deposit-taking, and thus, the level of its usage is in fact the highest. The whole assortment of financial entities such as central banks, governments, and individual investors have the U.S. dollar dominated asset types (U.S. bonds and other securities) at their disposal.
The continuation of the dollar’s lead on the world financial stage has to do with the size and capacity of the U.S. financial markets. America is known to be the country with the most sizeable and consequently rapid financial markets, making it the place where a plethora of investment opportunities can be found. The current condition has also led to the U.S. dollar being the most sought-after currency by the loaning of international money and national foreign exchange reserves.
Dollar’s Role in Global Reserves
Central banks of all the world put a large part of their foreign exchange reserves in the US dollar. According to the data provided by the International Monetary Fund (IMF), over 60% of the total global reserves are US dollars. For the countries, these reserves play a crucial role in achieving economic stability and the world’s financial system serves as a secure operation center.
The dollar’s domination with global reserves has proved very beneficial for the United States from many angles.
The following is an example of this: without pressure to devalue the currency in the short term, the United States has been in a trade deficit. Moreover, the migration of the USD reserves not only restrained US interest rates but also shaped a profitable credit market in the US.
One Dollar in General Banking
The worldwide banking influence of the U.S. dollar is apparent in the fact that it is the most vital currency in the world in terms of international transactions. It needs to be stressed that SWIFT, the world’s leading global money transfer network, manages trillions of transactions every year, with approximately 95% in the U.S. dollar.
A clear sign of dollar hegemony in the banking system is the immense diversity of USD-based assets in global capital markets. These assets include among other things U.S. Treasury securities which are without a doubt one of the safest investments globally. Central banks as well as private investors rely on the security and liquidity of such possessions to conduct suitable investment strategies.
One significant part of developing countries, the U.S. dollar has become the most critical factor for the economy. People in Africa, Latin America, and Asia use the dollar for their needs and as a support currency for their economy. Occasionally, dollar dependency comes from the lack of trust in local money and the financial volatility at home.
At times a country has officially adopted the American dollar as their currency, which is referred to as dollarization. To elaborate, the governments of Ecuador, El Salvador, and Panama are three great examples of states that have chosen to adopt the U.S. dollar instead of their local currency and also international investors have been willing to come to these countries.
The Influence of the U.S. Dollar in the World Debt Markets
One area where nobody questions the supremacy of the U.S. dollar is in the global debt markets. The majority of government borrowings in the debt markets of different countries across the globe are denominated in U.S. dollars. The same is true both of less and more economically advanced countries.
One reason why the dollar is an excellent choice in the global debt markets is that it is the primary currency for borrowing. As an illustration, U.S. Treasury bonds are the rating standard of the riskless and the most immediate investment vehicles for any background in the world. As a result, many countries seek loans in U.S. dollars and at the same time they exploit the U.S. financial markets‘ firmness and liquidity.
The Dollar and Global Trade Agreements
Many times, the U.S. dollar was the middle product in trade agreements, i.e. the result of the exchange was the U.S. currency. The point of fact is that most of the foreign transactions closed, are negotiated and completed in U.S. dollars. This state of affairs provides further confirmation that the dollar remains the currency of global trade.
For example, by denoting business agreements in U.S. dollars, many multinational firms are practicing one of the most reliable ways of hedging against currency risk. This approach not only certifies that both parties to the contract are using the same currency but also significantly reduces the chances of conflict and other problems that arise from fluctuations in the two parties’ currencies were the deal to go through.
The Role of U.S. Federal Reserve Policy
The monetary power of the U.S. Federal Reserve in preserving the ascendency of the dollar is a very important factor. The decisions of the Fed on its monetary policy, like raising or lowering the interest rates and conducting quantitative easing, can be of great influence on the world economy.
Since the US dollar serves as the major international reserve currency, the modifications in its monetary policy will greatly alter the economic flows worldwide. Mere illustration is the Fed’s act of hiking interest rates which, in its turn, leads to the appreciation of the US dollar because of this the global trade and finance will be affected. Besides, the Fed’s expansionary monetary policy can be seen as an attempt to skyrocket the U.S. dollar quantity in the world market, thus, it will be a contributing factor to the currency terms and inflation rates.
Geopolitical Implication of Dollar Dominance
The dominant position of the US dollar in the global market is a matter of great importance not least regarding geopolitical matters. By controlling the American financial markets and the dollar-dependent global financial system, the U.S. has been exercising its political leverage beyond the national boundaries.
Of all the tools deployed by the U.S., the most powerful one has been the ability to be the de facto global cophead of economic issues. A country’s financial system and the assets of that country being depensent on the United States are used as a powerful instrument for the sanctions imposed. To date, the United States has enforced financial sanctions to impair countries such as Iran, North Korea, and Russia.
Alternatives to the U.S. Dollar
Despite the massive predominance of the U.S. dollar in the world, there is indeed now an increasing attraction of the euro for world finance and the possibility of the yuan to become the important international finance currency. The EU has set the goal of the euro to be a suitable global reserve currency, while the Chinese government has put considerable effort to the yuan’s global acceptance.
However, the U.S. dollar did not only not lose its dominance but also enhanced it, through not only its stable and large market but also the U.S. economy itself. Nevertheless, the fear exists that the future might be a time when the powerful position of the dollar would be challenged because of the ongoing global power shift from developed to developing countries.
The U.S. Dollar of Tomorrow
The future of the U.S. dollar is still a topic that is widely talked about and discussed. On the one hand, some experts are very optimistic and strongly believe that the continuation of the dollar’s dominance will be possible in the future as it has a deep involvement globally in the sectors of trade and finance. However, others are convinced that digital money being adopted in large numbers and the influence of China will bring different challenges to the dollar.
It is expected that during the next few years, the US dollar will be used for most international trade and investments. However, if the move of the global economic power factor remains high and the dollar’s position still can be changed or the new competitors and technologies emerge at the same time, the financial ones that may still exist will change or share with the dollar, although this is not the only possible scenario.
Conclusion
The dollar’s dominance in global transactions and finance is attributed to the past events, monetary decisions as well as the financial system’s overdependence on it. While the most powerful currencies in the world can withstand the problems related to alternative ones and politics, the dollar remains the centre of the global economy. The potential that the chief role its application can offer to the US is quite a number, particularly economic and political powers, however its future will depend on the shifts in global trade, finance, and technology.