The pound may have survived many ups and downs, including almost being subsumed into the euro, but the days when it was the world’s most important currency probably ended around the time of the first world war. For the last century, the world’s markets have been dominated by the US dollar.
The greenback has become a global currency.
What is a global currency?
The countries of the world have around 185 currencies between them, and most are just waste paper outside their borders. A global currency is one of the few that is accepted for international trade. They include the euro, and the yen, but the U.S. dollar is the most popular. Around $580 billion in U.S. bills are used outside the country. In the former Soviet Union countries and in Latin America they may even be used as freely as the local currently, or in some cases preferred to it.
The universal acceptability of the dollar makes it the global currency.
The next closest reserve currency is the euro. The chance of the euro becoming a world currency has increased slightly as the eurozone crisis starts to get forgotten, but it remains a very poor second. The reason for the primacy of the U.S. Dollar is simply the strength of the U.S. economy. This means that the dollar is unlikely to fail, which the euro came close to doing.
The 1944 Bretton Woods agreement made this position official. Before then, most countries were on the gold standard, which meant that their governments promised to redeem their currencies for their value in gold. The world’s developed countries met at Bretton Woods, New Hampshire, to peg the exchange rate for all currencies to the U.S. dollar.
It’s not just dollar bills
Because the dollar provides a safe and stable means of exchange, many countries peg their currencies to the dollar, and most forex trading involves the U.S. dollar. As a result, foreign banks require a lot of dollars to conduct business, and a high proportion of the world’s debt is issued in dollars. This meant that during the financial crisis the U.S. Federal Reserve printed dollars to keep the global economy afloat.
The financial crisis made the dollar even more widely used. In 2017, the banks of Japan, Germany, France and the United Kingdom held more liabilities denominated in dollars than in their own currencies.
What happens now?
It is a well known truth that when America sneezes, the rest of the world will catch a cold. So if US dollars become more expensive, they are harder to afford if you are using another currency. Everything to do with trade becomes more difficult and expensive as a result.
This is not a problem for America, but it is for the rest the world. So now that interest rates are going up in the US, but staying pretty flat in most of the rest of the world, US assets are more attractive to investors.
As money flows towards the US and away from other places, the price of the dollar and US assets has gone up – and the price of other assets has gone down.
Turkey, Argentina and emerging markets have all suffered as a result, and investors have been acting more defensively.
Fortunately, the US Federal Reserve has no intention of triggering a new global financial crisis, and will hopefully put the brakes on the dollar’s ascent before it, and with it global trade, is out of everyone’s reach.
The value of investments can fall as well as rise and you may get back less than you invested.
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