Strength and Power of the U.S. Dollar
Reasons Why the U.S. Dollar Is So Powerful
The power of the U.S. dollar depends on its use as a global currency. This itself is backed by the power of America's economy. Here are a few reasons behind the enduring power of the dollar. They explain why no other currency will quickly replace it.
1944: The Dollar Is Declared the Global Currency
After World War II, the world's developed countries created a plan in Bretton Woods, New Hampshire. They fixed the rate of exchange for all foreign currencies to the U.S. dollar. The Bretton Woods agreement promised that the United States would redeem any dollar for its value in gold.
The 1970s: The Dollar Replaces the Gold Standard
By the early 1970s, countries began demanding gold for their dollars to curb inflation. Rather than allow investors to deplete Fort Knox of all its gold reserves, President Nixon untied the dollar from gold. By that time, the dollar had become the world's dominant reserve currency.
In essence, the dollar replaced the gold standard at this point. Most global contracts, especially those for oil, were denominated in dollars—and they remain that way in 2019. Many large economies, such as China, Hong Kong, Malaysia, and Singapore, peg their currency to the dollar. When the dollar weakens, so do the profits of their exporters. These countries also hold large deposits of U.S. Treasurys. In theory, they could sell their holdings and cause a dollar collapse. However, with export profits tied to the strength of the dollar, that's not in their best interest.
The Dollar Has Recovered From Past Declines
The dollar declined during the 1970s, the early '80s, and from 1991 to 1993. During these declines, there were also forecasts of a dollar collapse. Many countries considered removing their currency pegs from the dollar. But without a substitute for the dollar as a global currency, the countries kept their currencies pegged to the dollar, and a collapse did not happen.
Why the Euro Won't Soon Replace the Dollar as a Global Currency
In 2007, former Federal Reserve Chairman Alan Greenspan said the euro could replace the dollar as a world currency. At the end of 2006, 25% of all foreign exchange reserves held by central banks were in euros, compared to 66% in dollars. Furthermore, 39% of cross-border transactions were being done in euros, compared to 43% in dollars. In many areas of the world, the euro is replacing the dollar. The euro's strength is tied to the European Union's strength, which is one of the world's largest economies in 2019.
However, even if the euro is destined to replace the dollar, it would happen slowly. It would not cause a dollar collapse—again, a dollar collapse isn't in anyone's best interest. A dollar collapse would destroy the entire global economy. Also, the United States is the world's best customer. The countries that could cause a dollar collapse are the same ones who need Americans to keep buying their products. As a result, they have no incentive to turn against the dollar.
Another reason the shift to the euro would happen slowly—if it occurs at all—is because of the eurozone crisis that lasted roughly between 2009 and 2012. It forced the EU to realize that it must become a fiscal and governmental union if it wants to continue its monetary union. The scope and severity of the crisis highlighted key strategic differences between member countries' leaders. For example, German Chancellor Angela Merkel wanted to impose austerity measures to get debt under control, whereas French President Emmanuel Macron wanted to fund stimulus programs by creating a bond program for the economic bloc. As these debates raged on, the historical relevance of World War II and Germany's attempt to dominate the continent weighed heavy on leaders and citizens.
The U.S. Dollar's Strength: Recent Example
The dollar index tracks the value of the dollar. It rose 25% between 2014 and 2016. Why? First, in June 2014, the European Central Bank said that it would consider quantitative easing to lift the EU out of a deflationary, slow-growth spiral. Foreign exchange traders worried this would lower the value of the euro and started moving to dollars.
Just a month later, in the U.S., the Federal Reserve announced that it would end its quantitative easing program in October. This signaled the central bank's confidence in the U.S. economy. The FOMC Meetings Schedule recounts the Fed’s actions regarding the fed funds rate and its other monetary policies through the years.
Also in July 2014, the Bureau of Economic Analysis announced that the United States’ gross domestic product growth was an astounding 4% for the second quarter, from April to June. This was based on across-the-board growth. It was a welcome change compared to the first quarter's 2.1% contraction. The quarterly growth of the U.S. economy is reflected in the nation’s current GDP statistics.
In October 2014, Saudi Arabia announced it would not support the price of oil at $70 a barrel by limiting supply, reversing prior positions. A major reason was due to the strength of the dollar. Oil contracts are priced in dollars. A stronger dollar meant oil revenues were worth more. That created a flight-to-safety toward U.S. Treasurys and the dollar. The value of the U.S. dollar is a huge determinant of gas prices at the pump. A stronger dollar can mean lower oil prices.