August 19, 2024
The U.S. dollar is the world’s reserve currency. It’s held in large quantities by central banks and major financial institutions, and many commodities are priced in dollars. It’s considered safe for international transactions, international investments, and pretty much all aspects of the global economy.
How did the U.S. dollar achieve this? The post-war emergence of the U.S. as the dominant economic power delivered enormous implications for the global economy.
At one time, American gross domestic product represented 50% of the world’s economic output. As a result, it made sense the U.S. dollar became the global currency reserve. In 1944, following the Bretton Woods Agreement, delegates from 44 nations agreed to adopt the dollar as the official reserve currency. Since then, other countries pegged their exchange rates to the dollar.
People worry things will change. But that probably won’t happen anytime soon because there really aren’t any credible alternatives. See, you can’t build a dollar out of BRICs.
What is a BRIC? It’s an acronym for Brazil, Russia, India, and China. In 2006, these developing countries came together to challenge the political and economic power of North America and Western Europe.
The BRIC reserve currency argument is a non-starter primarily because of a lack of liquidity. These currencies are also unstable and generally lack global trust.
Investment manager VanEck pointed out how the Bank for International Settlements showed the U.S. dollar’s share of all currency turnover climbed from 85% in 2010 to 88% last year. In global finance, it’s similarly dominant.
The dollar also holds a unique position in global oil trading. Most market activity is denominated in it, even when transactions don’t involve the U.S.
And yet, the political will to change the reserve currency is apparent.
Brazil’s president called for emerging countries to move away from the dollar, while Saudi Arabia said it is in negotiations to conduct a portion of its oil trade with China in renminbi. Regardless, it’s impractical to trade commodities in non-dollar denominated currencies.
With the growing influence of the U.S. dollar, it’s likely here to stay.