The Global Reserve Currency

This is the story of the US Dollar. It has been around for almost 110 years only but it is the go-to currency for most countries. So let’s talk about how this situation was created and why it wasn’t any other currency that attained the top rank amongst fiat currencies.

So it’s 1913, and the US Federal Reserve was created to be able to stabilise the existing unreliable currency system that was based on banknotes issued by individual banks. And in 1914, the first US Dollars, as we know them today, were printed.

It was also around this time that the US economy became bigger than the UK (in terms of GDP). At this time though, global trade was still carried out mostly in British Pounds, since they had pegged their currency, before the US at least, to Gold and would therefore have been a stable currency. You can read more about the history of money here.

During World War I, most of the developed countries at the time de-pegged their currencies from Gold to be able to pay for the expenses of war using paper or fiat money. This directly devalued all of these currencies. The UK still did not do so, and it, therefore, had to borrow money during the war to keep itself going.

And the US became the lender to countries during this time, lending them money in exchange for dollar-denominated bonds. The British eventually had to move away from the Gold Standard in 1931, but by then the currency crown so to say, had been lost to the US Dollar.

As you may know, the US entered both world wars well after the fighting began. During World War II though, they supplied goods to the Allies and most of the payments were made in Gold. Due to this, by the end of WWII, the US held most of the world’s Gold and a return to the Gold standard became virtually undoable for all these countries (apart from the US obviously).

Now since the US had Gold, enough to keep their currency pegged to it, they were in a very powerful position. So in the year 1944, 44 countries met in Bretton Wood (in New Hampshire) to set up a foreign exchange system that could be acceptable to all. They decided that instead of linking all the currencies to Gold, these currencies could be linked to the US Dollar itself, since it was already linked to Gold.

This would have officially made the US Dollar the king of currencies, or more to the point, the world’s reserve currency. Other countries started accumulating dollars as forex reserves instead of Gold, and since the dollars needed a storage place, they bought US treasury securities (bonds and the like) in exchange for them, considering those to be safe.

In 1971, the US Dollar too was de-pegged from Gold, and the floating exchange rates that we have today were established. But we still use the dollar as the global reserve currency today. Most central banks in the world hold either dollars or dollar-denominated securities in their reserves right now. But while this has been the case until now, there is a push from some countries to create new currencies or strengthen their own currencies to take the fight to the dollar. We’ll talk about these countries sometime later.

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