The Rise of the US Dollar as the World’s Reserve Currency and Its Global Implications

The US dollar’s prominence as the world’s reserve currency is a cornerstone of the global financial system. Its journey from a fledgling currency to a dominant economic force reflects significant historical events and strategic financial decisions. Russia-Ukraine war and a looming global economic crisis, many countries, including Bangladesh, face growing concerns about the value of the dollar and dwindling foreign exchange reserves. This article explores the historical ascent of the US dollar, its current status, and the potential challenges to its supremacy as nations seek alternatives to reduce dependency on the dollar.

In various countries of the world, including Bangladesh, there is increasing concern about the value of the dollar and the shortage of foreign exchange reserves. The Russia-Ukraine war is creating a crisis in the global economy. Since the dollar is an international currency, the rise in currencies of different countries, like the Bangladeshi taka, Indian rupee, or Pakistani rupee, can have a good or bad effect on the economy of those countries. Also, international trade transactions are mainly in dollars, so if its reserves decrease, the economy of any country can be under pressure. 

Therefore, various countries are now looking for ways to reduce imports and have taken initiatives to reduce the consumption of imported products.  Countries are trying to reduce the dollar cost of importing fuel for electricity and vehicles.

In turn, everyone is worried about the decrease in the reserve of the dollar, which is why we have written this article about the importance of the dollar. Much of this article is taken from an article on the Investopedia website.

We all know that the US dollar is one of the strongest currencies in the world. But few clearly know how it became so powerful and became the world’s reserve currency.

The US dollar is the official currency of several countries besides the United States. It has quite a rich history; let’s not go into that for now. But for the first time, we all know this dollar currency was printed in 1914. Dollar printing began a year after the passage of the Federal Reserve Act and the establishment of the Federal Reserve Bank as America’s central bank. The first reserve note issued then was the $10 note with Andrew Jackson’s picture. After another three decades, the US dollar became the world’s reserve currency.

At A Glance:

1. Dollar currency was printed in 1914 after establishing the Federal Reserve Bank of the United States.
2. During World War I, the Allies paid the United States to supply gold, making the United States the largest hoarder of gold.
3. After the war, countries pegged their currencies to the dollar, and the gold standard ended.
4. The International Monetary Fund reported that 58.4% of the world’s bank reserves were held in US dollars in the fourth quarter of 2023.
5. Despite having such a position in the world market, the US dollar (in terms of value, the most expensive currency of the Kuwaiti dinar) is in 10th place in the list of the strongest currencies in the world.

History of the US Dollar:

The first documented use of paper currency in the United States dates back to the 1690s when colonial notes were issued by the Massachusetts Bay Colony. These notes were used to finance military operations. It wasn’t until 1776 when the first $2 bill was introduced nine days before independence. Nine years later, in 1785, the United States officially began using the dollar sign as the Spanish American peso sign. In 1863 the US government established the Office of the Comptroller of the Currency (OCC) and the National Currency Bureau.

These two organizations were entrusted with the management of the new notes. In 1869, the Bureau of Engraving and Printing began to issue coins in a controlled manner. Earlier, private companies used to print currency. The US Treasury officially assumed responsibility for issuing the nation’s legal tender in 1890, more than a decade before the creation of the dollar as we know it today and the Federal Reserve.

Gold Standard:

In 1913, the United States took steps to eliminate the instability and unreliability of the monetary system by establishing the Federal Reserve Bank through the Federal Reserve Act, which had previously been based on notes issued or printed by various banks. The US economy became larger during this period and surpassed the UK’s.

Most developed countries convert their currency to gold to stabilize their monetary system. However, when World War I broke out in 1914, many countries suspended the gold standard and started using paper currency to cover their military expenses, which devalued their currencies. Although the United Kingdom was still on the gold standard to maintain its position as the world’s leading currency, the third year of the war saw them borrow currency for the first time.

The United States had then become the lender of choice for many countries worldwide and was beginning to buy dollar-denominated US bonds. Britain finally abandoned the gold standard in 1931, which destroyed the accounts of international traders dealing in pounds. By then, the US dollar had replaced the British pound as the leading international reserve currency.

Bretton Woods Agreement:

As in World War I, the United States participated in World War II after the war began. Before directly participating in the war, the United States was the main supplier of arms and other essential goods to the Allies. Most countries then paid their prices in gold, making the United States the world’s largest gold holder at the war’s end. Countries that thus emptied their gold reserves could never return to the gold standard.

To solve this problem, 700 delegates from 44 allied countries of the world met in Bretton Wood, New Hampshire, in 1944 to decide on a definite system for managing foreign exchange that would not cause any country to lose. That delegation decided that the world monetary system would no longer be on the gold standard but could be pegged to the US dollar. This is known as the “Bretton Woods Agreement”.

This agreement establishes the authority of central banks to maintain a fixed exchange rate of their currency against the dollar. Instead, the US will supply US dollars for gold on demand. Countries then had some control over the weakening or strengthening their currencies against the dollar. They could trade their currency to control the money supply.

Becoming the world’s reserve currency of the US dollar:

The USD was officially crowned the world’s reserve currency by the Bretton Wood Conference, and the US was backed by the world’s largest gold reserve holder. Instead of gold, other countries started to reserve US dollars and buy US Treasury securities as a safe way to reserve their dollars.

Demand for Treasury securities, the deficit spending needed to finance the Vietnam War, and Great Society programs greatly increased the supply of US paper money. Countries that held dollar reserves then began to convert dollars back into gold reserves, worried about a stable dollar market. Demand for gold soared, and US President Richard Nixon was forced to intervene and cut gold’s connection to the dollar, leading to the current floating exchange rate. Although stagflation began with high inflation and unemployment, the US dollar remained the reserve currency.

Current Status of US Dollar:

The USD is still the world’s reserve currency. According to IMF, central banks of various countries hold about 58.4% of their reserves in US dollars in the fourth quarter of 2023. Some of the dollar reserves are held in cash, and some are in US bonds, such as US Treasury bonds.

Dollar-denominated debt outside the U.S. is rising, reaching $13.4 trillion by mid-2022. Many argue that this makes the dollar the strongest currency in the world. However, according to CMC Markets, the dollar is currently ranked as the 10th strongest currency in the global market despite the dollar’s position and dependence on it. The site ranked the Kuwaiti dinar as the strongest currency, while the British pound and euro ranked fifth and eighth, respectively.

Which country’s currency could be the next world reserve currency?

Several alternative currencies are poised to take the dollar’s place as the world’s next reserve currency. The euro is now second only to the dollar is most widely used reserve currency and could overtake the dollar if economic conditions favor it. However, the European Union (EU) lacks a central treasury unit, which is a hindrance in this regard. China’s renminbi may outperform the dollar, the country’s leading figures are realizing. 

China and Russia are chief among the countries seeking to break the dominance of the dollar as a global currency. Especially after the start of the war in Ukraine, Russia is feeling the need for Russia. On the other hand, China wants to build a new world order where the power of America will decrease and the importance of China will increase. And that is why they want to break the dollar’s supremacy as a global currency.

The task is not easy at all. Because 60% of the foreign currency reserves in all central banks worldwide are in dollars. And then there is the Euro 20%. Euro countries are very close allies of America. They are very close allies of America politically, economically, and militarily.

Russia, China, and India are also interested in conducting foreign trade transactions using their currency, the rupee. But China’s political relations with India have been bad for decades. Therefore, there will be doubts about how sustainable the trade between India and China will be in their currencies, bypassing the dollar.

One of the main reasons for going outside the dollar and trading in our currency is the extreme dependence on the dollar. It has become a weapon of America. During the Russia-Ukraine war, America and various European countries have imposed different types of trade sanctions on Russia. As a result, Russia may be slowly heading towards an economic crisis. 

Bypassing the dollar and trading in one’s currency certainly have some advantages and disadvantages. The dollar’s value is relatively stable, and almost all the world’s countries have been doing foreign trade based on the dollar for the past 100 years. Now, doing transactions in one’s currency can create complications. Bangladesh will then have to manage the transactions of Taka-Rupee with India, Taka-Yen with Japan, Taka-Pound with Britain, and Taka-Euro with Germany, which will be challenging. A country’s internal problems can depreciate its currency. For example, Sri Lankan Rupee and Pakistani Rupee have depreciated in recent years. 

The US dollar’s status as the world’s reserve currency results from a complex interplay of historical events, strategic economic policies, and international trust in its stability. While alternatives like the euro and China’s renminbi show potential, the dollar’s entrenched position, supported by substantial foreign reserves and widespread use in global trade, makes its displacement unlikely in the near term. However, the geopolitical dynamics exemplified by the Russia-Ukraine war and resulting sanctions underscore the risks of over-dependence on a single currency.

As countries like China, Russia, and India explore ways to diversify their trade transactions, the future may witness a gradual shift in the global monetary landscape. Nonetheless, the transition away from the dollar will be complex and fraught with challenges, ensuring the dollar’s dominance for the foreseeable future.

Source:

1. How the U.S. Dollar Became the World’s Reserve Currency
2. Why UK energy prices are rising much faster than in Europe
3. ‘Kuwaiti Dinar most valuable currency in the world’ Share
4. What are the strongest currencies in the world?
5. International status and usage of the euro
6. This is why the US dollar is a potent sanctions weapon… for now
7. The historical depreciation of the Sri Lankan rupee
8. Pakistani rupee sinks to all-time low against US dollar
9. Dethroning King Dollar Won’t Be an Easy Feat
10. Ukraine and Dollar Weaponization