The state of the US dollar

The US dollar has been the world’s dominant reserve currency since the signing of the Bretton Woods agreement in 1944.

Under this agreement, in an attempt to prevent a repeat of the protectionist monetary policies of the 1930s that led to a global depression, developed nations set the exchange rate for their currency against the US dollar. In turn, the U.S. set the value of the dollar against gold and pledged to trade dollars for gold at any time. With physical support in this way, the U.S. dollar provided central banks around the world with a liquid “hard” currency that they could hold in reserve to settle international trade accounts. Everyone would accept the dollar as payment.

This regime finally broke down in 1970, when the persistent trade deficit in the United States provoked fears about the weakening dollar and, therefore, its gold reserves had to be taken advantage of. In today’s world of free floating currency, the role of foreign exchange reserves has changed. They are no longer intended solely to pay for temporary imbalances in import and export imbalances, but are used as investment funds that also deter attacks by currency speculators.

However, in recent decades, the US dollar has remained by far the world’s main de facto reserve currency; 66% of the international central bank’s foreign exchange reserves are held in US dollars. This reserve status also means that all major commodities are priced and traded in only US dollars and traders have to buy US currency to access the goods. Therefore, the question of whether the US dollar can maintain its privileged role as a major international reserve currency is key to assessing future demand and therefore its value.

In recent years, the size of US debt obligations (currently around 65% of GDP) and a continuing budget deficit (currently 11% of GDP), along with the emergence of the EU as the largest economy in the world, they led the economy. commentators to question the sustainability of the dollar’s reserve status.

In 2007, former Federal Reserve Chairman Alan Greenspan declared that it was “absolutely conceivable for the euro to replace the dollar as a reserve currency, or to be traded as an equally important reserve currency.” “. Similarly, at the 2008 World Economic Forum, George Soros commented: “The current crisis is not just the crisis following the housing boom, it is basically the end of a 60-year period of credit expansion. based on the dollar as a reserve.

In January 2009, the Russian central bank announced that the euro-based share of its reserve assets had risen to 47%, surpassing investments in dollar assets of 41%.

However, as the spread of the financial crisis continued to spread in late 2009, and fears about sovereign solvency in the EU and the strength of the economic recovery in the United States dollar has regained strength. Risk-negative investors, who were eagerly looking for “safe haven” assets, returned to the low-yielding dollar. This inverse correlation between the strength of the dollar and investor confidence, the so-called “risk trading”, was summed up by Martin Wolf of the FT: “In the recent panic, the children returned to their mother despite that their mistakes did a lot to provoke the crisis. “

So while central bank reserve managers today remain nervous about the U.S. fiscal position, they are basically struggling to find a preferred alternative currency. The eurozone sovereign debt crisis has called into question even the survival of the single currency, Britain’s financial position now looks even worse than that of the US and Japan’s huge debts are very close to the yen . Shortview in the FT summed up the continued, albeit hesitant, preference for the dollar: “Investors call it the ugly sister problem: no one thinks the U.S. dollar is Cinderella, but it’s probably the least reprehensible of the group “.

Therefore, while the US dollar may be back in favor today, it appears to be due to relative strength and short-term risk aversion, rather than a vote of confidence in the US economic fundamentals. long-term. It remains to be seen, however, whether there is a realistic alternative to moving central banks away from the dollar and other reserve assets. If, or when, this change in reserve status can occur, and what the consequences will be for the U.S. economy, are the key questions that will drive the long-term value of the U.S. dollar.

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