Why Dollar is International Currency?
Welcome to my blog! Today I am just about to explain to you why dollar is international currency. How it became the king of all currencies? Why is it so important?
Currently, almost 180 different currencies are being used in 197 countries of the world. Some of them are valid in more than one country such as Euro. More than two dozen countries of the European Union (EU) use Euro as their primary currency. Likewise, US Dollar is also the fundamental currency of more than 14 countries.
The whole world also has reserves of foreign currency in addition to their currencies. These reserves are called Foreign Exchange reserves. The major purpose of foreign exchange reserves is to trade internationally and in other transactions.
There an interesting fact is that more than 59% of foreign exchange reserves are in the form of only US dollars. Besides, China has the highest US dollar reserves of $3.46 trillion. China is an emerging superpower but undoubtedly, the USA is the current superpower. Its economy is the most powerful country in the world. And its currency is considered the king of all currencies.
The inception of Paper Currency
Different systems have been applied for trading and financial transactions in different periods. At the end of the 19th century and the beginning of the 20th century, the financial system of the world was different. It was transforming into different paper currencies formally.
At that time, there was a need of the hour to create a common system for international trading and financial transactions. All countries had their currency and there were no proper rules for the printing and circulation of money. Hence, every country would print the money and use it. Consequently, there were difficulties while trading internationally.
To solve this difficulty, most countries took a unanimous decision. They decided that each currency should be valued at a specific quantity of gold. And that government should have enough gold to print more currency.
For instance, in 1873, the value of 1$ was set at 1.504 grams of gold. Hence, to print 1000$, the US government should have 1504 grams of gold. In simple words, each country cannot print its currency more than its availability of gold. This was decided at that time.
But, after World War 1, this system got collapsed.
Impacts of World Wars on the World Economy
Countries that were involved in World War 1, needed a lot of money for different war expenses. To meet this need, countries started printing money again blindly. Eventually, inflation became too high in those countries as per the gold rule. The value of their currency got reduced.
Great Britain was a superpower and its colonies were all over the world. They tried their best to maintain their currency value or the position pegged to gold. But eventually, in 1931, they abandoned the gold standard behind the currency. Therefore, pounds devalued. And international traders who used pounds in trading got extremely affected. Moreover, Great Britain, a superpower also had to borrow money to meet its expenses.
The national deficit of Great Britain reached 7.8 billion pounds in 1920, after World War 1. Before the war, in 1913, it was only 600 million pounds. And, after World War 2, it became 21 billion pounds. This amount was almost thrice their Gross Domestic Product (GDP).
Similarly, other countries like Russia, Germany, and France also suffered severe deficits.
World Wars and the US Economy Policy
In both World Wars, the diplomatic and economic policy of the US was rational. The United States participated in these wars first as a merchant and then as a war participant. The whole world was engaged in these wars.
Meanwhile, the United States was busy manufacturing machinery and war weapons. The production of cotton, and wheat, and searching for precious metals were its main agenda. And, it was doing this with all its manpower as well as its capital.
It utilized its full resources to maximize its exports. Consequently, America saw the world’s greatest economic boom. And it did it in a very short period and emerged as the world’s largest exporter.
In the Early and Middle 20th Century
Between 1913 and 1917, in just 4 years, total US exports rose from $2.4 billion to $6.2 billion. This was almost thrice. While at that time superpower Britain’s exports were a mere $2.5 billion.
Similarly, at the beginning of World War 2, the USA was not an official war participant. That’s why it utilized all its resources to enhance its exports. In 1945, US exports reached more than $10 billion. Most of them were exported to Britain and Russia. In contrast, Britain’s exports were only $3 billion. An interesting fact is that there was a condition kept by the US. The condition was that it would sell all the goods only in return for its currency, dollars, or gold only.
Other countries did not have dollar reserves. Hence, they imported goods in return for gold. Thus, the USA collected the maximum gold reserves.
The United States created humungous beneficial business opportunities for itself. It did this from these two wars when the world’s economies of the world’s superpowers were being affected by war. The United States became successful in accumulating three-fourths reserves of gold through trade. America’s gold reserves jumped from 2,000 tons in 1910 to 20,000 tons in 1945. It was a huge boom.
Because of this amazing United States economic development during these wars, it became the last option to lend money to several countries. During World War 2, in 1941, America began supplying major war equipment and other aid to allies under the lend-lease act.
Under this Lend-Lease act, the American government could lend, lease, or grant war equipment. It could do it to any country, instead of selling goods. This aid or loan aimed to provide defense assistance to the countries. And in return, their security was considered crucial to the security of the United States.
By this time, the United States was not an official participant in World War 2. And it was neutral in world conflicts. So much of this aid was sent to Britain and other countries. Those were already on the opposite side of Germany and Japan. and they had no money to buy arms anymore.
It was the Lend-Lease act, which enabled Great Britain to continue its war practically against Germany and Japan.
Aftermath Pearl Harbor Incident
After the Pearl Harbor incident, in December 1941, when America became part of World War 2 officially, it continued to aid still under the Lend-Lease act. By the end of the war, the USA had provided $50 billion in aid to more than 30 countries.
Due to all these factors, the US dollar began emerging as a strong currency. It was the occasion in 1944 when the USA gathered officials from 44 countries. The US signed an agreement that became the basis of making the US dollar a world currency.
1. Bretton Woods Agreement – First Stage
In 1944, in Bretton Woods, New Hampshire, delegates from 44 allied countries met for an agreement. They met to orchestrate a system to manage foreign exchange reserves. it was planned that would not be harmful to any nation. They concluded that world currency would no longer be pegged to gold. But, the US dollar would be eventually pegged to gold.
The price of 1 ounce (1 ounce = 28.35 grams) of gold was then set at $35. This agreement is famously known as the Bretton Woods agreement.
What were the benefits of other countries in this agreement?
Actually, at that time, America had maximum gold reserves. While other countries had depleted their gold reserves because of war expenses. Hence, they conceded to this agreement. Nevertheless, under this agreement, it was the USA’s responsibility to print only as much money as there are gold reserves available equivalent to the value of the currency.
In this way, the currencies of these countries were linked with gold indirectly.
Under this agreement, the authority of central banks was also established, which would maintain fixed exchange rates between the US dollar and their currencies. Moreover, the return of gold in exchange for the US dollar to the countries was also part of this agreement.
In this agreement, the US dollar was accepted as an international trade currency. Now, two countries can trade even if they don’t trust each other.
For instance, if Britain exports $1 million worth of goods to France, it was sure to Britain that it can get gold from the US in return for the $1 million, it receives from France.
On the other side, if Britain receives 1 million francs instead of $1 million, and if France prints more money, then the French Francs can be devalued, and thus Britain would be affected by the loss. Moreover, if Britain wants to use these francs for trading with any country and if that country has no faith in France, then those French Francs would have been of no use to Britain.
Establishment of the World Bank and IMF
Because most of the countries were severely affected by economic loss after World Wars, so, all these countries needed loans to restore their economy as well as infrastructure. To meet these needs, the World Bank gave huge amounts of loans to them.
Moreover, the IMF was established to monitor the world economy and provided loans to small countries to ease their balance of payments difficulties. Thus, the Bretton Woods agreement gave a prominent position over other countries. This was the first stage where the US dollar gained precedence over other currencies, and it emerged as the global currency.
2. Trading Petrol in Dollars – The Second Stage
When all countries were engaged in World War 2 in the 1940s, meanwhile Middle east was relaxing in deserts, being clueless about these war disasters. They had no idea that they were sitting over the largest oil reserves in the world. At that time, Britain and the USA were the only countries that had the capability of extracting, process, and trading it.
Meanwhile, in 1938, an American Company discovered a large oil deposit in Saudi Arabia and embarked on extracting it. At that time, the economy of Saudi Arabia was not strong, because oil had just started to be extracted from their land. During the war, Italy shelled several times on US installations in Saudi Arabia. Saudi Arabia was in dire need to protect its land and installations.
It was the time when then-US president Franklin Roosevelt realized that oil is mandatory to get long-lasting development in the world. That’s why, after a long meeting with the Saudi ruler King Abdul Aziz, he made a historic deal that permanently changed the fate of the dollar. According to this deal, the US will help Saudi Arabia to avoid any possible attack in the future. For this, the US will provide any kind of modern weapons, and in return, Saudi Arabia will sell its oil against the US dollar. Thus, oil was sold in dollars, and from here, the rise of the Middle east started.
In 1960, after the establishment of OPEC (Organization of Petroleum Exporting Countries), oil trading started in US dollars formally.
But how and why dollar became an international currency just by trading oil for dollars?
Here comes the third stage:
3. Cancellation of Dollar with Gold Exchange – Third Stage
According to the Bretton Woods agreement, any country could get gold in return for US dollars. Consequently, in 1970, the US gold reserves decreased to only 10,000 tons. This was the time when it became almost impossible for the US to return gold in exchange for US dollars.
At that time, then-president Richard Nixon temporarily canceled the agreement of the gold exchange rate against the dollar. Now, no country’s currency was linked to gold reserves. Thus, there was no scale to determine the value of any currency.
In this context, the US dollar was the only currency by which the most valuable commodity of the century could be bought, which was oil. Therefore, most of the countries used to have foreign exchange reserves in the form of US dollars, so that they could buy oil from Arab countries in exchange for dollars.
US Treasury Bonds – The biggest reason why the dollar became international currency?
An important aspect here is that prosperous countries have a lot of foreign exchange reserves but they only limited quantity of reserves for trading with other countries.
For instance, if a country has total foreign reserves of $100 billion, it uses only $20 billion for trading and the remaining $80 billion would be in reserves.
These countries invest their additional foreign reserves in US treasury bonds. These bonds are issued by the US government so that they would get a reasonable profit for it.
Foreign countries held approximately US $7.4 trillion in US treasury securities. This huge amount is more than the combined GDP of India, Russia, and France.
With this vast amount of money, the US has added the advantage of funding economic growth industrial production and even large financial institutions like the IMF and the World Bank. Besides these benefits, the USA has major control over other countries.
Not only this, rather if a country tries to go against its will, the US can freeze its dollar reserves in the US. A significant example of this is the recent sanctions imposed on Russia, by the USA.
Now, the USA controls its currency and even it has no restriction to back that currency with gold.
Based on all these reasons, America is the superpower and the US dollar is a strong global currency also known as the King of all currencies.