Dollar’s Reserve Currency Status is in Danger

Dollar’s Reserve Currency Status is in Danger

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The US dollar has been the default currency for the purchase of commodities and a universal trading currency that has remained in an unchallenged position for decades – up until now that is. The US dollar has been a reserve currency worldwide since 1944, but that may all be about to change since the Euro and Chinese yuan, or renminbi, have become appreciably more powerful currencies. Actions taken during Richard Nixon’s presidency in the 1970s may now be about to bite America on its backside, and there seems little that it will be able to do to stem the tide of change that appears to be taking place at the moment. To understand the crucial nature of this situation, a brief history lesson may help to put everything into context.

How the Dollar Became World Reserve Currency

Prior to the US dollar, UK sterling, or the pound, had been the global reserve currency. Inextricably linked to the value of gold – the first ‘reserve’ currency – this was the financial standard up until the end of the First World War. With the subsequent upheaval to the world order, rather than continuing to use sterling as a reserve country, countries instead began to set up trade and economic barriers in an effort to increase their power on the world stage which, when combined with competitive devaluation, was responsible for the worsening of the Great Depression which lasted from 1929 to 1939.

However, it was not until 1944 and as the Second World War was drawing to a conclusion that many of the world’s countries agreed to meet at Bretton Woods, New Hampshire in the USA. In an attempt to learn lessons from the previous 25 years, a number of suggestions were put forward with regard to removing trade barriers in such a way as to benefit economies worldwide. Ultimately it was decided that the US dollar should supersede the UK pound as the global reserve currency, but to protect against the USA inflating or deflating the value of the US dollar to its advantage, what became known as the Bretton Woods treaty saw the US dollar linked directly to the value of gold at a fixed rate of $35 per ounce.

As reserve currency is also used to help countries and economies worldwide which find themselves with a substantial negative balance of payments on the trade front, an international fund of $8.5 million was set up (that sum being worth much more back then). The 730 delegates who attended Bretton Woods subsequently agreed to establish two new financial institutions, the International Monetary Fund (IMF) which would be able to monitor exchange rates and lend money, and the World Bank Group which had the responsibility of providing financial assistance for reconstruction necessary as a result of the war, whilst also assisting less well-developed countries.

In 1958 the full extent of the Bretton Woods system became operational as global currencies became convertible, thus enabling international trade balances to be settled in dollars as the value of the dollar was still fixed at an exchange rate of $35 per ounce of gold. As long as the US was able to adjust the supply of dollars in order to retain confidence in future gold convertibility, the system would work. However, as a result of the United States’ continual negative balance-of-payment deficits, the volume of overseas-held US dollars began to far exceed the country’s gold reserves, at which point, during Richard Nixon’s presidency, the US came off the gold standard as by that time, in order to meet its currency obligations abroad, the dollar would have to have been devalued to US$400 per ounce of gold.

Dennis Gartman: Growing Trend to Price Commodities in Other Currencies

Owing to the vast number of dollars held overseas, plus the relative weakness of other foreign currencies, little actually changed and the dollar remained a reserve currency. In addition, the dollar had been issued by a large trading nation and was also seen as a stable currency, two major selling points for a reserve currency. But today America’s power, or rather that of the dollar, is no longer what it used to be. As the combined resources of the European Union and its 28 members have seen the Euro strengthen, and China emerge over recent years as a major global economic player, the US would seem to be powerless to stop this two-pronged attack. According to the well-respected economist and editor of The Gartman Letter, Dennis Gartman said recently, “We might be seeing more pricing of crude oil in Asia in renminbi terms. We may be seeing greater pricing of grains in Europe in euro terms. We may be seeing a greater pricing of base metals in yen terms in Asia. I think that’s really what’s happening here.”

“This all began because of a loss of confidence in the U.S. to begin with,” Gartman also said. “We are less strong than we used to be, and we’re perceived to be weakening.”

US Dollar Without Gold Standard Will Lose its Reserve Status

The dollar may have stood a better fighting stance if the US gold reserves were what they once were at 20,000 tons back in 1958. However, by the 1970s that had shrunk to 8,000 tons when it came off the gold standard and though today it still holds the largest gold reserves by some way, 8133.5 tons compared to second-place Germany with ‘only’ 3381.2 tons – the IMF holds 2,814.1 tons – Gartman’s suspicions that the US is perceived to be weakening financially makes the reduction in gold reserves even more critical. It does not help that quantitative easing (the printing of new currency out of thin air) has recently become the US default action to combat deflation and to keep the economy from sinking into a recession. This form of financial policy does little other than weaken one currency in relation to another, especially at a time when China’s yuan, or renminbi, is likely to be tied directly to the value of gold, a commodity it has been buying heavily and, equally, forbidding gold to be taken out of the country.

So what happens if the dollar loses its status as the world’s reserve currency? The demand for dollars would drop massively, the value of the dollar would sink, and Americans would have to pay much more for the imported goods they buy. This would bring on an economic crisis of major proportions and with world economies tied to one another more than ever, no country would be immune to this economic tsunami.

Note: The opinions expressed in this article are the author's own and do not necessarily reflect the view of Alvexo on the matter.