Why the Dollar Remains the World’s Reserve Currency

Reckless Federal Reserve creating global monetary bubble

America came into the Second World War two years after it started, but before that it sold large quantities of American goods to the Allied forces: weapons, war materials, ships, and so on.

The bills for all these products and commodities were settled in gold, and American gold reserves were the highest in the world.

By 1944, when a victorious outcome of the war was fairly predicted, representatives of the Allied nations and their central bankers met at Bretton Woods in New Hampshire, where it was agreed that (a) the US dollar would be accepted as the settlement currency for international trade; (b) that the US dollar would be redeemable in gold on presentation at the fixed rate of $35 to the ounce; and (c) the International Monetary Fund (IMF) would be formed to ensure that the US behaved itself and maintained the agreed ratio by controlling the supply of its dollars.

Gold: The World’s First “Reserve Currency”

This is how the US dollar became the world’s “reserve currency.” This term is derived from the fact that the original reserve currency was gold — in the sense that trade debts were settled from the debtor country’s gold reserves.

However, for both security and convenience, the US dollar became the world’s reserve currency because it was guaranteed to be fully convertible into gold. In earlier times the British pound had held a similar position, mainly because the Bank of England was trusted to maintain a steady relationship between the value of sterling and gold. French imports of Italian goods, for example, could be paid for in sterling, taken from sterling reserves held in the Banque de France, which the Italian exporters would have been happy to accept.

In the years following the war the IMF completely failed in its founding purpose. Throughout the 50s and early 60s the US just kept on printing dollars regardless of whether they could redeem these dollars in gold at $35 to the ounce. They were effectively paying for their imports with fake currency.

In 1958 General Charles de Gaulle became president of France and he noted with some alarm that the French Central Bank was stuffed full of US dollars, and French exports to the US (wine, cheese, machinery, cars, clothes, etc.) were being paid for by still more dollars. In 1969 de Gaulle instructed his economics adviser, Jacques Rueff, to redeem 80 percent of the dollars they were holding against gold at the official rate of $35 to the ounce.

Other central bankers duly noted this redemption and soon began to follow suit. By 1971 America’s gold reserves had become seriously depleted, and President Nixon took the coward’s way out of the problem by simply declaring that dollar holdings were no longer convertible into gold — effectively taking America off of what remained of a gold standard.

(As an aside, Nixon could have faced up to the reality of America’s systematic dollar destruction over the previous decades. He could have devalued the dollar by restating its revised value in terms of gold. Professor Patrick Barron has made tentative calculations that suggest a true relationship between dollars and gold in 1971 at around $400 to the ounce. If correct, this means the dollar lost almost 90 percent of its purchasing power over the 27 years from 1944 to 1971.)

Unrestrained Fiat Money

Many readers will know the story of The Sorcerer’s Apprentice, based on a poem by Goethe, in which the idle apprentice, in his master’s absence, eases his chores by bewitching his broom into fetching water for him. But he doesn’t know the magic formula for “un-bewitching” it, so he watches helplessly, in growing horror, as the broom fetches more and more water until the entire house is bursting.

Instead of water, in this case, think dollars. The sorcerer, of course is the US Treasury and the wayward, but clueless apprentice, is the Federal Reserve, America’s central bank. By cutting the dollar’s ties to gold in 1971, fiat money creation by the US Treasury took off big-time. In the years that followed, the US was a major world power in every sense and was, in particular, a huge importer of goods and services (and an equally huge exporter of dollar-denominated Treasury bills in settlement!). As a consequence 80 percent of the world’s central bank reserves were held in the form of US dollars. Since then, as governments around the world have grown more circumspect regarding the US Treasury’s ability to maintain the purchasing power of its dollars abroad, that percentage has fallen to around 60 percent.

It is estimated even now that US dollars held in overseas central banks amount to some $5 trillion, of which Bank of China and Bank of Japan hold $1 trillion each.

American imports are paid for in fiat dollars. If the Chinese yuan, say, were gradually to challenge the US dollar as a superior store of value measured against gold, the dollar’s hegemony would be seriously undermined, and all those US dollars held abroad would steadily find their way back to the US, causing massive inflation.

The American government continues to get away with this fraud on its own people, largely because the countries that trade with America are fully complicit in the chimera of the dollar’s credibility. After all, the potential impact on employment levels in their home industries would be calamitous if American sales were to be lost.

Source: Why the Dollar Remains the World’s Reserve Currency

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3 comments on “Why the Dollar Remains the World’s Reserve Currency
  1. I read the Chinese Yuan (RMB) is now the fifth reserve currency after US dollar, Euro, British pound sterling and Japanese yen.

    That and China and friends are now trading in local currencies (RMB, YEN, and RUB) for goods and oil.

    More importantly some of THEIR customers are buying bulk goods and oil in Gold which may cause the USD petrodollar to slide.

    Liked by 1 person

  2. Reminds me of the story :The Emperor with no clothes”…….Anyone see what I mean? 🙂

    Liked by 1 person

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