Why Do Dollars Become the World Currency?

  • It is undeniable that the US Dollar has become the world's currency since the past decade. Despite having experienced a recession, stagflation, war, and various other upheavals, the US Dollar remains chosen by the majority of countries in the world as a reserve currency. How come? What makes a currency so valued?

    Here are some reasons why the US dollar is the world currency

    1. Economic Strength

    The main reason why a country's currency can dominate is, of course, number one is its economic strength. In the past, the basis of the assessment was how much gold was available, but now it's different. The greater the Gross Domestic Product (GDP) of a country and the volume of cross-border transactions, the greater the demand for its currency.

    More than just a matter of how healthy the economy is, a country must be the centre of demand for goods and services, so that its currency can be easily available, supported by a strong economic sector, and free from government interference.

    It is undeniable that until 2016, the United States was the country with the largest total GDP and very consumer-driven growth, in addition to having various large-scale international industries. The exchange rate of the currency is fully left to the market mechanism, without any direct intervention from the government.

    2. Military superpower country

    Military strength, both in terms of personnel, weapons, and intelligence of the United States, is difficult to compare. Throughout the history of mankind, especially in the era of colonialism and world war, a series of events in which a currency strengthened accompanied by dominant military forces was not just one or two.

    In the September 2015 Military Strength Index report, the US ranked first, followed by Russia, China, Japan, and India in the top five. It could be said that a country that is militarily strong is not just the US. However, the currencies of these countries do not necessarily meet other requirements such as dollars, and they certainly do not occupy the first rank.

    3. Foreign Diplomacy Prestige

    Every country tends to conduct trade and financial transactions with other countries with whom they have good relations. This is one of the strongest reasons why the Dollar is the world currency. US diplomacy strengths outperformed other countries, even compared to those who have the economic and military power that is almost able to compete. This is because the prestige of diplomacy is not a matter of how many countries are "afraid", but of how capable the diplomat team lobbies, has friends, and expands networks.

    Following this logic, a country whose currency does not sell usually has bad relations with other countries. Take the example of a Zimbabwean state whose currency has been destroyed. In fact, there are sanctions for Zimbabwe from the European Union due to Robert Mugabe's government human rights violations. Or North Korea, which practically only has trade relations with China, is also said to have limited currency in that region.

    In this context, it is understandable how the United States involved and dozens of trade agreements and cross-country alliances can make the dollar a world currency.

    4. Stability and credibility accepted everywhere

    If you want to go shopping at the mall, then, of course, you will make sure that in the wallet there is a legally valid money (not fake money) or a bonafide bank debit/credit card, which can be accepted by many merchants. Likewise, inter-country transaction actors will ensure that the currency they use has adequate credibility and will be accepted by the counterparty. Many countries make US Dollars the only major foreign exchange reserves for this reason (as well as the three points above).

    Can the position of the dollar as a world currency be replaced?

    Yes, it's possible. Those who have the ability to achieve the four conditions above are not just the United States, even though Sam's uncle is currently superior. In fact, according to IMF data, the portion of the US Dollar in the composition of world foreign exchange reserves has continued to decline from year to year. A number of other currencies began to rise, especially the Euro.

    There are various reasons why some countries reduce the portion of the Dollar in their foreign exchange reserves. Among them is the practice of the US budget deficit which resulted in it bearing a high proportion of Debt-to-GDP (reaching 104.17% based on the latest data). The decline in the value of the US Dollar from time to time also made many parties less like it. The decline was alleged because this currency no longer linked its value to Gold as in the Bretton Woods agreement.

    However, even though the prestige of the Dollar began to fade, it can be seen how far enough the other Currency must go to remove its dominance as the world currency. China is currently ambitious to install Yuan (Renminbi) into the world currency, but needs to pioneer trade agreements with many countries first, also gradually releasing control of the value of its currency from the government to market mechanisms.