This is the ‘US Dollar’ – a simple paper note, that looks like any other currency bill, but the whole world is a slave to $. Let me give you a food for thought.
For the USA, dollar is not just a medium to trade, but a tool to control you, your national interests, and the global economy. In the past few months (after a pandemic period, 2022-2023)), despite of economic turmoil, increasing layoffs, rising unemployment, and fear of recession, the dollar is strengthening consistently.
The U.S. Dollar Index which measures USD’s strength against a basket of six other currencies, appreciated over 12% in 2022. This brings me to ask a few obvious questions:
Q1. Why every other currency in the world is compared with the dollar?
Q2. Why global trades are conducted in US dollars?
Dollar is the global currency
See China is the second-largest global economy & India is the fastest growing economy in 2022. But neither Yuan (Chinese Currency) nor Rupee (Indian Currency) has much credibility outside these nations. However, the dollar is acceptable globally (easily tradable anywhere) including China & India, which is one of the reasons that makes $ the Currency of the World.
For example: you cannot buy a coffee at Starbucks in London, New York or Dubai using Rupee or Yuan, but you can with US dollars.
How dollar became the world’s reserve currency?
Before the WWI:
• Most global currencies were linked to gold,
• Whatever amount of notes that were printed by Central Banks was backed by an equal value of physical gold in the treasury.
• That means gold was the backup of every currency.
After WWI & WWII:
• Major European countries exhausted their gold reserves, which created a lack of confidence in the gold standard that only worsened economic difficulties.
• As World War II ended, and without gold reserves, the currency value of these countries reduced to zero.
• These lead Western powers to meet & develop the Bretton Woods Agreement.
Bretton Woods Agreement linked all other currencies to the USD, which was the only global currency that was linked to gold & considered the most stable currency. As a result, USD became the dominant reserve currency as the USA was holding 75% of the global monetary gold. The US agreed to exchange dollars for gold at a fixed rate of $35 per ounce.
[Fact: By the end of 2022, the government of the USA holds more than 8,100 tons of gold — the largest stock on earth.]
Till this time “gold” was on top of the hierarchy followed by “the dollar” and all other currencies were pegged under the dollar. Later in 1971, the US government abolished the gold standard, which gave the US Fed complete control over the US dollar. That means gold went out of the hierarchy & dollar comes at the top.
How do trades generally work globally and its consequences?
Globally, a large amount of trade invoicing is made in dollars. For example, China & India, despite of being neighbouring nations conduct their trade in dollars instead of their respective currencies. It is because the dollar is considered to be a global, safe and stable currency (as discussed above).
All these demands in dollars in turn depress the dollar interest rates, which makes it a cheap funding currency and as a result, it encourages larger borrowing in dollars.
Therefore, the dollar becomes the ruling currency in the foreign exchange market. More than 90% of forex trading involves dollars & approx. 40% of the global debt is issued in dollars. As a result, banking institutions across the world require a lot of dollars to conduct business.
Petro Dollar System – The petrodollar system is essentially the global practice of exchanging oil for US dollars, rather than any other currency. This means that no matter what country is buying the oil, they pay the oil-producing country in petrodollars, which are denominated in US dollars.
