History of the US Dollar as the Reserve Currency of the World

There was a streak of events in history that made the economy of the US strong enough following the British economy that its currency, the US dollar, is now the world's reserve currency.

It all began in the late Eighteenth century when the USA emerged to be one of the most significant economies for numerous economies of the Western world, especially Latin America.

Early Beginnings

• 1785: The United States formally designated the dollar as its currency following the Continental Congress' declaration.
• 1792: The Coinage Act founded the U.S. Mint and implemented a fixed-basis bimetallic standard using gold and silver.
• 1800s: As the British pound sterling, the world's largest Empire's currency, dominated world trade, the U.S. dollar slowly increased in stature as the economic power of America developed.

The 19th century witnessed the United States evolving from a fledgling power to a powerhouse of economics. As the industrial strength of America grew, so did the global presence of its currency, the US dollar. Nevertheless, throughout the 19th century, sterling was still the world's most prevalent reserve currency, leaving very little room for any other currency. But the US dollar continued to grow its footprint and became indispensable to most countries in bilateral exchanges with the US as the US reconfigured its industrial capacity. The British Sterling was still the most powerful currency in the world during the 19th century.

World War I and Its Aftermath

• 1914-1918: World War I weakened European economies, including Britain, to a large extent.
•  1919: America became a net creditor country for the first time instead of a debtor.
•  1920s: The dollar started competing with the pound as a reserve currency of the world, as European countries borrowed large sums from America.

The destruction of Europe in WWI redirected economic influence westward across the Atlantic. The United States, little affected by direct destruction from the war, placed itself in the unheard-of situation of being the world's biggest creditor nation.

The Interwar Period

The interwar years from 1920 to 1939 saw plenty of history in the existence of Europe that led to crises and political destabilization.

• 1925: Britain went back onto the gold standard, but only at an unsustainable pre-war parity.
•  1931: Britain departed from the gold standard during the Great Depression.
•  1933: President Roosevelt removed the U.S. from the domestic gold standard.
•  1934: The Gold Reserve Act of 1934 devalued the dollar relative to gold.

This crisis period witnessed numerous currency crises and realignments, with no currency fixed as the global reserve. International use was facilitated by both dollar and pound currencies, but a lack of stability meant that either could not truly act as a sound reserve currency.

Bretton Woods System

The Bretton Woods System was a significant turn as regards the reserve currency. It revolutionized the world altogether, making the US dollar the global reserve currency.

• July 1944: Delegates of 44 Allied countries met in Bretton Woods, New Hampshire, creating a new international monetary order.
•  1944: The accord fixed large currencies to the U.S. dollar, which in turn could be converted to gold at $35 an ounce.
•  1945: The IMF and the World Bank were established as institutions under the Bretton Woods system.

The Bretton Woods conference is the official start of dollar dominance. By pegging other currencies to the dollar, and only the dollar to gold, the system effectively made the U.S. dollar the world's reserve currency by design.

Golden Age of Dollar Dominance

The period from 1950 to 1970 was the golden era of dollar dominance.

• 1950s-1960s: American economic supremacy and the dollar's gold backing cemented its position as the world's primary reserve currency.
•  1960: The U.S. held approximately 55% of global gold reserves.
•  1960s: Growing U.S. deficits led to concerns about the sustainability of the gold exchange standard.

During this time, foreign exchange reserves, international loans, and international settlements of trade were denominated more and more in dollars. The term "as good as gold" came to be replaced by "as good as the dollar" in international finance.

Nixon Shock and Transition

The years between 1969 and 1974 were a time of shock and transition and turbulence under President Nixon's leadership.

• 1971: The Smithsonian Agreement tried to salvage fixed exchange rates without convertibility to gold.
•  1973: August 15, 1971: President Nixon stopped the convertibility of the dollar into gold, thus putting an end to the Bretton Woods system.
•  Major currencies started floating freely, marking the total downfall of the Bretton Woods system.

Although the gold-dollar connection ceased to exist, the dollar continued to be a reserve currency. This proved that the dominance of the dollar had now surpassed its backing with gold and was now backed by the overall performance of the U.S. economy, the depth of its financial markets, and geopolitical clout.

Petrodollar System

The petrodollar system continued to make things easier for the dollar.

• 1974: The U.S. and Saudi Arabia signed a historic deal in which Saudi oil would be priced in U.S. dollars only.
•  1975-1980: Other OPEC countries followed the Saudi example and established the "petrodollar" system.

The deal guaranteed continuous world demand for dollars, since any nation desiring to buy oil would require dollars to buy it. It de facto substituted oil for gold as the underlying commodity for the dollar's reserve currency status.

Modern Era

The decade of 1980-2010 witnessed the ascent of numerous currencies like the Japanese Yen, German Mark, Euro and Chinese Yuan. Nevertheless, the supremacy of the US dollar was not lost.

• 1980s-1990s: Despite threats from the Japanese yen and German mark, the dollar continued to be in its prime position.
•  1999: The Euro came into being, generating the first serious possible threat to dollar dominance.
•  2000s: Amid rising U.S. deficits and the 2008 financial crisis, the dollar paradoxically gained strength in times of international uncertainty.
•  2010s: The Chinese yuan grew more significant but was still significantly behind the dollar in international use.

Even as America's portion of the global economy has been relatively falling, the dollar has continued to reign supreme because of network effects, the size and liquidity of U.S. financial markets, and the absence of adequate substitutes.

Current Status

The United States dollar represents some 60% of the world's foreign exchange reserves and is used in roughly 85% of foreign exchange transactions worldwide. The dollar continues to be the international trade currency, currency of foreign debt issuance, and the unit of price quotation for commodities.

In spite of occasional forecasts of its death, the reserve status of the dollar has been surprisingly durable, showing the exceptional staying power of network effects in international finance and the ongoing robustness of the U.S. economy and institutions.