Why is the dollar important to the world economy?

The historically predominant presence of the dollar within the global economy has been called hegemony of the US dollar. It is currently the world’s reference and reserve currency, representing 60% of global reserves.

In addition, it is the currency preferred for savings, exchange of raw materials and as a peg currency in countries experiencing inflationary processes.

Its predominance is due to the confidence that is had in that currency worldwide, even when other currencies have strengthened. The importance of the dollar and its consolidation in the world economy is basically due to historical factors.

Historical events that favored the dollar

  • The Bretton Woods agreement. In a meeting, the rules that would handle financial operations internationally from 1944 were generated. It was decided to reestablish the gold standard as a mechanism to reactivate and order world exchange. The US dollar would be the reference currency as long as it was convertible and backed by its gold equivalent. The US could not print more money than would be backed by the gold protected in its vaults.
  • Despite the Bretton Woods agreement, the US suffered financial problems in 1960 and decided to increase its funds through the Federal Reserve by printing paper money not backed by gold. From that moment the dominance of the dollar would be based on trust.
  • After the oil crisis of 1973, the countries grouped in OPEC began to obtain income through foreign exchange in dollars. This allowed the development of their economies and increased indebtedness in dollars.
  • During the cold war, many countries continued to trust and safeguard their reserves in the US dollarEven the Soviet Union and China, already outlined as world powers, become important creditors and place a good part of their reserves and bonds in the US. At the same time, Latin American countries are beginning to experience inflationary crises that force them to increase their debts in US currency.
  • What seemed like a new threat to the hegemony of the dollar in the face of the global crisis of 2008 turned out to be a new circumstance to strengthen it. Given the possibility that world banks could not pay their debts in that currency, the United States Federal Reserve issued a considerable amount of dollars. This prevented the fall of reserves in the Central Banks of the world between 2008 and 2018.

Why is the dollar so important in the world economy?

Some economists predict the loss of the hegemony of the dollar basically due to fiscal excesses and its highly overcrowded economic policy. However, the economist Mark blyth points out that you cannot live without the dollar and it will continue to be the standard and exchange currency par excellence. The reasons for such strength are:

  • Since countries on all continents use it as a currency of exchange for commercial transactions and to save their reserves, the end of the hegemony of the dollar would imply a collapse of the capitalist system.
  • Trade in oil and other raw materials occurs almost entirely in dollars with no possibility of being substituted by another currency.
  • The financial system and the stock markets are dollarized and the collapse of the dollar would imply the paralysis of world economic activities.
  • Foreign countries are constantly acquiring dollars and most investors and currency holders are looking for maximum returns. Thus, they prefer to invest in the safest asset that they are United States Treasury Bonds.
  • In times of crisis and recession in a country or region, markets become volatile. Governments need to make adjustments to stabilize their public debts and they do this through the acquisition of dollars.

What are the advantages and disadvantages of the hegemony of the dollar?

The most important currency in the world obviously favors the US since it can print money every time it needs to pay its bills without implying a devaluation of the currency or risks of hyperinflation. For the other countries, it also has advantages but they are not without drawbacks.

  • When countries adopt the dollar as their official currency to curb inflation or solve economic crises, their competitiveness decreases and the cost of living of consumers increases.
  • The strength of the dollar brings with it a strong control on the part of the United States over the productive economic systems and central banks of other countries.

Attempts to challenge the dollar standard

  • The Euro has been among the first options as a possible substitute for the dollar. However, the 19 member countries of the European Community have not consolidated a true unity and do not have the backing of a political structure that makes the Euro a completely safe currency.
  • In 2014, a summit made up of Brazil, Russia, India, China and South Africa (BRIGS) was held. The need for their financial transactions to be carried out in their own currency and the creation of their own bank as an alternative to the World Bank was raised. They were based on the fact that the combined GDP of these countries is double that of the US.
  • Russia, China, France and Germany proposed the Special drawing rights as an alternative currency, a basket of FIM currencies for world reserves.
  • Some countries increased the purchase of Japanese bonds. However, Japan is not interested in putting its exchange rate at risk and affecting its exports. Japan decided to buy dollar assets to reduce the value of the yen.
  • China has tried to increase the importance of its currency. It has established currency exchange agreements with other countries. It established a trading system that allows oil to be bought in Chinese currency. However, there are many doubts that the yuan could be an alternative to the dollar. There is strong distrust in the Chinese economy due to its economic slowdown, restrictions imposed by the government on the outflow of money from the country and arrests of foreigners.

Everything seems to indicate that beyond any attempt to replace or diminish the importance of the dollar, this currency supports the globalized capitalist system by functioning as a world reserve, peg currency and international means of payment for the most important commercial transactions.

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