Why is US Dollar World’s Base Currency?

Why is US Dollar World's Base Currency?

US has been a super power since long! And the supremacy comes largely also with the fact that its currency is base indicator and is used as a medium of exchange for huge transactions across the globe. But how did US dollar came to this prominence? Has it been like this forever? We are here to tell you the story of how US dollar became the base currency of the world.

Crux of the Matter

Each nation’s Central Bank keeps foreign exchange reserves. Globally, all such reserves are reported in US Dollar (USD), making it the base currency worldwide. You would have also seen that most currencies today are quoted in dollar terms only.

But, the question is: What made the USD global base currency ?

Rewind to World War I
In 1914, world’s major transactions were conducted in British Pounds (£). By the end of World War I, Britain had lost quite a chunk of money and for the first time in the history, Britain had to borrow money from the outside. With this, Pound lost most of its value and the only lender of choice which also replaced the former was US Dollar.

During World War II
During World War II, US was the main arms supplier to all of its allies. During the 1940s, Gold was the major medium of all trade. Thus, in return of all the weapons supplied, US used to get paid in Gold, making it the largest holder of Gold.

Bretton Woods System
Leaders from 44 nations met in the town of Bretton Woods, New Hampshire to establish a stable system of managing foreign exchanges that does not put any nation at a disadvantage. Thus, came into the existence the famous Bretton woods System as per which: The world’s currencies were linked or more precisely pegged to the US Dollar. While the US Dollar was linked/pegged to Gold.

Crowning of the Reserve Currency
With Bretton Woods System, US Dollar became the official reserve currency of the world. Reserve Currency is one of the fundamental mediums of exchange for global trades and transactions, making Central Banks to hold them in huge amounts.

The Working
The exchange rate for currencies worldwide was fixed at $35 per ounce of Gold, meaning, for every ounce of gold that nations deposited with the US, they got US $35 in return. Thus with Bretton woods, instead of Gold, countries started accumulating US Dollars.

Collapse of Bretton Woods
In 1971, US ran into financial deficits owing to the Vietnam War combined with funding of various development projects. In order to finance the same, they started printing money, flooding the global market with USD. As world nations were worried of the stability of the US dollar, they started converting their USD reserves and Treasury Bills back to Gold.

But at that time, total US dollars held overseas were much more than the Gold held by the US, which also broke the premise of Bretton Woods Agreement. US in no way could suffice the Gold demand with its existing reserves. And hence, the then President Richard Nixon de-linked the US Dollar from Gold.

The collapse established the present day floating system – wherein the market forces of demand and supply determine the exchange rate of global currency.

Nonetheless, USD with 61% share in currency reserves held by global central banks is still considered to be world’s reserve currency.

  • The International Monetary Fund (IMF) was set up during the United Nations Monetary and Financial Conference in Bretton Woods in 1944. Currently, the Chief Economist of IMF is Gita Gopinath.
  • The World Bank was also created during the Bretton Woods Conference in 1944. The motto of the organization is ‘Working for a World Free of Poverty’.
  • Presently, Kuwaiti Dinar (KWD) is the highest-valued currency in the world.