Dollar as the World’s Reserve Currency

Introduction

The 1944 Bretton Woods agreement made other world countries switch from backing their currencies with gold to backing them with dollars. It was proclaimed that it was possible to redeem dollar reserves in gold upon request – a promise that was broken by President Nixon who separated the dollar from gold. Nixon’s government’s fiscal actions led to a phenomenon called stagflation, a combination of inflation and stagnant growth. In the following decades, the dollar went through some declines which, however, did not undermine its role in international trade, making it possible to make assumptions about its undeniable benefits for the US economy. This paper will examine how exactly the dollar as the world’s reserve currency may be benefiting the US and discuss possible downsides and challenges.

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Benefits for the US Economy

Probably the most substantial benefit of having the dollar as the world’s top reserve currency is its liquidity, a characteristic that affirms the ease of trading in the international financial markets. A study by Aldasoro and Ehlers (2018) showed that global financing conditions remain linked tightly to the monetary policy of the United States. Doing business in a country that has control over one of the world’s reserve currencies eliminates two major problems that typically manifest themselves when international companies are trading across the borders. First, if two or more collaborating entities use the same currency, their profit does not depend on the exchange rate and its shifts which would be the case were they to trade in two different currencies. Second, a situation when an importer uses a currency that is difficult to trade outside their country is not likely to occur. The most recent statistics revealed the ease of trade for the United States: in the 2019 ranking by World Bank Group (2018), the US scored 92 points out of 100 for the said criterion. In short, US companies gain easier access to foreign capital.

Drawbacks of the Dollar as the World’s Reserve Currency

For all its benefits, one should not overlook the possible drawbacks of having the dollar as the world’s reserve currency. So far, the United States has been actively resisting the attempts to introduce a new world’s reserve currency as per the proposal of China and Russia. Yet, some experts point out that the replacement of the dollar with an International Monetary Fund’s basket of currencies may serve as a long-awaited relief for the struggling US economy (Norloff, 2014). For instance, it is speculated that a world without the dollar would boost the US economy and help it eliminate the major part of its debt. There are some other pressing issues caused by the dollar. One of them is the overvaluation fueled by foreign governments actively purchasing dollars which pushes US manufacturers to produce less and reduce their staff number. To balance the accumulation of the dollar abroad, the US government fosters a current-account deficit which further deepens the discrepancy between demand and supply.

Conclusion

One may contend that the dollar plays the most substantial role in global trade and finance. After all, over two-thirds of the international reserves are assets denominated in dollars, and the dominant share of the currency is used outside of the United States of America. The dollar’s prevalence supersedes that of the second largest world’s reserve currency by a significant margin, and some are convinced that the US only benefits from overruling the international trade. This claim is valid to a certain extent since the dollar smoothens trading across the borders and eliminates many potential difficulties. Still, on the other hand, the dollar as the world’s reserve currency might be held accountable for the US growing debt, underwhelming production, and shortages in the workforce.

References

Aldasoro, I., & Ehlers, T. (2018). Global liquidity: changing instrument and currency patterns. BIS Quarterly Review, 17-27.

Norloff, C. (2014). Dollar hegemony: A power analysis. Review of International Political Economy, 21(5), 1042-1070.

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World Bank Group. (2018). Doing business 2019. Economy reform. Economic profile. United States. Web.

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Paperroni. "Dollar as the World’s Reserve Currency." June 11, 2022. https://paperroni.com/dollar-as-the-worlds-reserve-currency/.

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Paperroni. 2022. "Dollar as the World’s Reserve Currency." June 11, 2022. https://paperroni.com/dollar-as-the-worlds-reserve-currency/.

References

Paperroni. (2022) 'Dollar as the World’s Reserve Currency'. 11 June.

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