US DOLLAR AS A GLOBAL CURRENCY.

 THE US DOLLAR AS WORLD RESERVE CURRENCY. WHAT DOES THAT MEAN?

March 23, 2023

The first US dollar was printed in 1776. Nine years later in 1785, the US began printing bank notes using the “$” sign.  (The “$ “ sign for US currency was adapted from the Spanish peso symbol—which was an “S” with a “P” for “peso” superimposed. The US dollar sign was an adaptation of that idea, printed as an “S” with a “U” superimposed to signify “US” and to create: $, originally with two vertical lines. ).   

By 1913 when the US economy had grown to be the largest in the world the Federal Reserve Bank was created, and a year later in 1914 the “Fed” began printing $10 dollar (Jackson ) Federal Reserve Notes. To insure confidence in the national currency, each note was backed by gold bullion held in Fort Knox, Kentucky.  (In 1914 gold was valued at     $ 20.67 per oz, so turning in a “Jackson” got you one ounce of gold!).   The USA and most western countries at this time held to what was known as the “gold standard”.   The USA backed up bank notes with gold and noted that with the printed guidance on each note: “redeemable in gold on demand”. (Until 1933 when FDR made holding gold in the US illegal). This gold-backed paper helped to create confidence in the currency and facilitate trade and ease international monetary transactions for US businesses and traders.  The gold standard of pegging the value of a currency to the price of gold avoided the pitfall of “fiat” currencies. Fiat money had no intrinsic value.  Its value was based only on the promise that the issuing government would honor the value of the note. Fiat money had the problem that issuing nations could simply print up more “paper” in times of economic stress and manipulate the value of their currencies to enhance trade or attempt to control economic cycles.  This often led to disastrous bouts of inflation and economic chaos. Devaluing a nation’s currency could also impact fair trade relations. The gold standard avoided  this significant problem. 

During early years of WW I and WW II the USA, remained a neutral nation, supporting the allied belligerents as a  major supplier of war materiel. US allies paid for weapons and supplies mostly in gold. But as the war wore on, many had to revert to paper (promissory notes ) or fiat money.  As a result of this favorable export trade, the US mint at Fort Knox accumulated gold bullion.  Even at the present time, the US is claimed to hold over 8,000 tons of this heavy (19 x heavier than water), soft, yellow, shiny stuff. 

As WW II began to come to a close, western allied nations attempted to plan for the economic recovery in the post war period. They were faced with the realization that the war had drastically altered  the stable gold standard system that had served them so well in previous decades.  In most allied nations , gold bullion reserves were badly depleted, as a result of war expenses. On the other hand, the US repository for gold at Fort Knox was overflowing  with bullion as a result of its favorable trade balance during the two world wars.  This drastic imbalance of gold reserves  with only one nation holding most of the gold bullion made a return to the old and stable system of backing up all national currencies with gold impossible. 

Near the war’s end in 1944, delegates from 44 allied nations met at Bretton Woods in New Hampshire to decide on how to manage  paying for trade and other foreign exchanges under these new circumstances in a way that would not severely disadvantage any one country. 

The solution at Bretton Woods was a simple one. Since the US dollar was  backed by gold, the other world currencies could be pegged to the value of the dollar and rhus be indirectly  linked to the value of gold.   The Bretton Woods agreement was a compromise that permitted member nations to retain some of the stability of the former gold standard under new, post war circumstances.  It was in this way that in 1944 at Bretton Woods the dollar became the world’s global currency..its reserve currency. 

The nations signing the Bretton Woods Agreement promised  to each establish a central bank that would fix the exchange rate between its national currency and the dollar ..and in turn the US agreed to continue to redeem US dollars in gold on demand. The attendees set the value of gold at $35 dollars per ounce.

This made the US “greenback” the world’s reserve currency. Instead of hoarding gold, countries could simply accumulate reserves of US dollars.  They could store their dollars in US Treasury Bonds (securities). Which at the time came to be seen as “safe as gold”. 

The result was that money flowed freely from abroad into US banks and the Fed, as foreign banks purchased and accumulated treasury securities. The demand for US bonds and other gold backed securities  was so great that these securities could be offered at low rates of interest at maturity.  Thus US treasuries and other US securities became a source of cheap borrowed money for the US government. This system had a negative aspect in that the demand for dollars made borrowing money cheap (interest rates were low) and thus  encouraged government borrowing and deficit spending.

The US government’s perennial penchant for spending much more than it annually collected in tax revenue—known as deficit spending—eventually caused trouble.  Massive deficit spending by the  U S  government to finance foreign wars (the Vietnam War) and President Johnson’s “Great Society” resulted in the government printing more paper money than it had gold to redeem the notes with at Fort Knox.  Foreign nations becoming aware of these circumstances began to lose confidence in their holdings in US treasury notes..and slowly began a move to convert their dollars into gold.

By 1970mUS government spending and over printing of money had outstripped the amount of gold held in Fort Knox.  By 1971 government treasury officials officially warned that the dollar was “overvalued”.   This led foreign investors to fear that the US government would  devalue the dollar.  Such a move would generate huge losses for many investors who held large amounts of the dollars as reserve currency. That fear of devaluation in the early 1970 led to a collapse in confidence, and the beginnings of a full scale sell off of US securities and calls for redeeming their value with gold.  But the US did not have enough gold reserves. 

To avoid this “run” on the Fed,  President  Nixon, in 1971, on his own recognizance and with no warning, acted to decouple the dollar from gold.  The immediate result was that billions of dollars held by individuals and foreign national banks were no longer redeemable  in  gold. The run on gold at Fort Knox ended but this act also ended the gold standard for US currency—converting the US dollar into a “fiat” currency. Foreign investors and others were unhappy with Nixon’s impetuous and one-sided decision, but had no recourse. The dollar, now, no longer backed by gold was valued  only on the basis of the US government’s ability and  promise to honor its debts  has remained as the world’s reserve or global fiat currency since then.

 

A nation having a “reserve” or global currency has great advantages. Major commodities like grain, feed stocks, fertilizers, meats, and especially petroleum products  are traded in dollars. Since most nations hold large amounts of dollars, trading in dollars facilitates, simplifies and reduces risk to traders.  Since trading nations must replenish their dollars …..It also makes it easier for the US government to access loan money at low rates of interest….and thus to spend freely and at times irresponsibly.   

Note: April 1,  2023

I read today that China and Brazil, the former the largest economy in the world, and the latter the largest economy in South America, have agreed to abandon the dollar as a reserve currency and use their own currencies in their $150 billion dollar annual trade. China and Brazil thus join Russia, India, South Africa and several other former USSR nations which have or are planning to abandoned the dollar.