Why is the US dollar still the currency that matters the most globally?

My answer on Quora:

Of all the currencies around the world, the US dollar matters the most globally because it is most readily available, most widely accepted in international transactions, and, crucially, the most trusted.

If little country A is selling a commodity, for example, to little country Z, that transaction is most likely to take place in US dollars because it is much easier for both countries A and Z to exchange their currencies for dollars than it is to exchange their currencies for one another’s. It is also less risky for the seller in country A to price her commodity in a more stable currency than her small country’s currency which may fluctuate in value more often. In fact, most, if not all, major commodities sold globally are priced in dollars and transactions are conducted in dollars. That makes the dollar pretty important!

Why is this the case?

Because there is no other alternative to seriously threaten the dollar’s grip on global finance. In the post-World War II years, the international monetary system operated on the gold standard. But countries did not use actual gold as a means of payment. They still used their currencies. The value of their currencies was tied to gold, via the US dollar. In other words, the dollar was tied to gold, and other currencies were tied to the US dollar.

In 1971, President Nixon ended the gold standard by tying the U.S. dollar not to a fixed supply of gold, but to the trust and faith in the credibility of the U.S. government. This marked the beginning of a new era, and one that central bankers still grapple with today. Values of currency are now heavily influenced by trust. Perception is everything, and perception is based on a sound economy and strong institutions that uphold mutually agreed on rules.

In the end, the U.S. stands out in the world as having the deepest and most liquid financial markets in a system that is trusted to be based on laws that are upheld in court. This is not to say that other countries don’t have this, but it is saying that investors around the world trust the U.S. and the U.S. has an open, deep and liquid financial system (not to mention the head start it had by helping craft the post-war global monetary system).

Case in point: When S&P downgraded U.S. government debt in 2011, the dollar strengthened. Why? It was still seen to be the most stable store of value in the world.

 

 

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