The US Dollar and Reserve Currency Status#

Historical Context#

Since 1945, following the end of World War II, the US dollar has served as the primary reserve currency globally, replacing the British pound.
This shift occurred due to the economic strength of the United States in the post-war era, where the US emerged as a dominant global power with substantial industrial and financial resources.

Established in 1913, the Federal Reserve is the central bank of the United States.
Its role in the global financial system is pivotal because of the dollar’s reserve currency status, influencing monetary policy, global trade, and international finance.

A system where global currencies were pegged to the US dollar, making the dollar the central axis of international trade and finance.
The US dollar was convertible into gold at a fixed rate of $35 per ounce, ensuring trust in the currency’s stability.

This system backed the value of a country’s currency with a specific amount of gold reserves.
Countries participating in the gold standard promised to exchange their currency for a fixed quantity of gold, providing a tangible measure of value.

By 1971, mounting economic imbalances emerged due to:
- Excessive money printing beyond actual gold reserves to support growing economic demands.
In response, President Nixon ended the dollar’s convertibility into gold, a move termed the “Nixon Shock”. This marked the collapse of the Bretton Woods system and the transition to a new monetary era.

After 1971, major global currencies floated against each other, allowing market forces of supply and demand to determine exchange rates.
The global economy transitioned from a gold-backed system to a fiat currency system, where currencies derive value from the trust in and stability of their issuing governments, rather than physical commodities.

The term “debasement” refers to the reduction in a currency’s value, often due to inflation.
The Federal Reserve actively targets a 2% annual inflation rate:
- This reduces the purchasing power of the dollar over time but encourages spending and investment, considered essential for economic growth.
While inflation erodes the dollar’s value, it remains a tool for managing the modern fiat-based economy.

Impact of Interest Rates: By raising interest rates, the Fed can reduce inflation and strengthen the dollar by making it more expensive to borrow money. Conversely, lowering rates can stimulate the economy by making borrowing cheaper, but can lead to inflation.
Economic Cycles: The discussion touches on how economic cycles of boom and bust are influenced by these monetary policies, with examples like the dot-com bubble, the 2008 financial crisis, and the speculative bubbles in various asset classes.