Last Updated on September 2, 2022 by Daniel Cardoba
Today, you can find almost every single country in the world that uses a national currency. This means that there are only two main categories of currency in existence – fiat (backed by nothing) and commodity (backed by gold or silver).
But why was it that the U.S. dollar became the world’s reserve currency? And why has it remained the most popular fiat currency in the world despite its printing problem?
Let us look at the historical events that led to the emergence of the U.S. dollar as the world’s reserve currency.
How did the USD become the world’s reserve currency
After WWII, the U.S. became a much stronger country and became the default leader of the western pact in the cold war against the U.S.S.R. Many of its allies decided to adopt USD.
By creating the U.S. dollar as the official currency of the United States, the U.S. government made the dollar the first international currency of the world. Now, any country could use U.S. dollars to pay for goods or services because they accepted it as valid payment since the U.S. influence is widely accepted in the world.
This created an economic model that allowed everyone to have access to the U.S. dollar without having to physically hold them. At this time, nobody knew what else would be possible once the USD system went live on the planet.
The result was that the U.S. dollar became the first global currency to ever go mainstream, and it set up the foundation for the rest of the world to follow. As of today, more than 7 decades after its creation, the USD remains the most widely used currency in the world.
Decades ago, the USD was pegged to the gold value, but Richard Nixon decided to dump this “gold standard” to make the USD much more flexible and more tied to the Federal Reserve’s policies.
Why does the USD remain the strongest fiat currency
When the USD was first introduced in the 1940s, the U.S. dollar was worth way less than today. Things changed, and nowadays, the U.S. dollar has become the main reserve currency of most central banks all around the world.
The fact that the United States remains the most dominant country in the world is one of the reasons why people still prefer using USD even though cryptocurrencies are now gaining popularity worldwide.
To understand how the USD became so powerful, let us look into some key reasons that make it unique.
First of all, the USD used to be backed by gold. The U.S. dollar was the only currency in the world that (at the time) was fully backed by physical gold. In a sense, the U.S. dollar was the best version of a fiat currency since it is the only one that is not only legal but also fully backed by something that exists in real life. No other currency can claim such a title.
Despite the fact that the USD ditched the gold standard a few decades ago, the influence that the United States has over other countries remains too strong. This is why it’s very hard to replace the USD as the international currency since the U.S. government has too much influence over everybody else.
And don’t forget that the USD is backed by the full faith and credit of the U.S. government. The USD is the currency of a sovereign state which means that it is completely under the control of the federal government.
The USD is only issued by the Federal Reserve Bank (FRB) and its monetary policies have affected the entire world, as we can see from its interest rate hike policies in the past half year (first half of 2022).
Not only that, the USD is widely accepted as a stable store of wealth. Unlike commodities like oil or gold, the USD is not prone to high volatility. Most nations around the world rely heavily on the USD and other fiat currencies to manage their foreign exchange and trade.
And due to its usage as the international currency, the USD is highly liquid. Financial institutions are able to easily convert USD to any other currency (i.e. Euro, Pound Sterling, etc.) whenever it is needed because of how liquid it is.
The USD itself is very secure. Thanks to technology, it takes just seconds to transfer USD online or through apps. You don’t need to worry about losing your cash because the USD is digitized and backed by the U.S. government.
All the facts above have helped how the USD can maintain its popularity in the world. The reason why the USD is the preferred currency of the majority of the world is due to the fact that it is the most commonly-used currency among the population. There are many reports that show that the number of USD users globally exceeds those who use the Chinese Yuan, Euro, British Pound, Japanese Yen, and Russian Ruble.
The Disadvantages of USD
Above I have explained all the good things about USD, but how about its disadvantages? What many people may not know, however, is that the USD is not a free lunch. There are several disadvantages to using the USD as your primary currency.
First of all, the USD is a debt instrument. When the U.S. government prints USD, it creates new debt. In order to keep the value of the USD stable, the U.S. government must continue issuing new debts each year.
The thing is, the Federal Reserve keeps printing money as a solution to all their problems. Even after the recent interest rate hikes, they already hint at a plan to do another Quantitative Easing (Q.E.) to print more money.
Secondly, the USD is a centralized currency. Because the USD is backed by the U.S. government, it has been controlled by people with political agendas.
Thirdly, It is expensive to buy USD. If you want to purchase a large amount of USD, you will need to pay a lot of taxes on top of the price of the currency itself. That makes it difficult to buy USD when you don’t have enough money.
Another factor is the fact that the USD is not suitable for small purchases. And with the recent interest rate hikes, the dollar has become even more expensive than before.
Alternatives To USD When It Comes To The World’s Reserve Currency
As you can see, there are many benefits to using the USD as the world’s reserve currency. However, there are also several drawbacks to using the USD, which make it less attractive compared to other currencies.
If you are looking for a viable alternative to the USD, here are three good choices that might replace USD one day.
Cryptocurrencies offer a lot of advantages to those who wish to escape the USD. They are decentralized, they are digital, and they are borderless.
Bitcoin is the pioneer cryptocurrency, and it is considered to be the biggest winner in the crypto world. Other cryptocurrencies include Litecoin, Ethereum, Ripple, Dash, Monero, ZCash, E.O.S., Stellar Lumens, and hundreds of others.
These cryptocurrencies might be much easier to use than the USD. With cryptocurrencies, you don’t need to deal with fees, government regulations, and other problems that come along with using the USD.
However, the current cryptocurrencies aren’t perfect either. Many of them are unstable and volatile. Their value is often affected by the overall performance of the crypto market. If you invest in cryptocurrencies with the intention of making a profit, you may end up losing some money instead. And since most people only use cryptocurrencies for speculation purposes (instead of ideological purposes), I don’t see crypto replacing USD anytime soon as the world’s reserve currency.
Finally, there is the third option of choosing – commodities. Commodities are valuable assets that can be used to produce things. Examples of common commodities include metals, grains, and energy sources.
One thing to note about commodities is that they are hard to move from one place to another.
For instance, if you try to sell corn in America to someone in Australia, you won’t be able to complete the transaction unless you ship the corn via airplane or boat.
Since commodities are mostly stationary, they tend to be stable in terms of value. However, this does not mean that they are immune to market fluctuations. A rise in demand for the same commodity can lead to a decline in supply resulting in a drop in the value of the commodity.
Other Fiat Currencies:
One of the most realistic options to replace the USD as the world’s reserve currency is other fiat currencies. As we all know, many analysts often predict the yuan will eventually replace USD. Not sure if this is true or not, but the possibility is there. Russia also recently said the BRICs would create a new global currency to lessen their USD dependency. Whether they will be successful or not in this plan remains to be seen.