The US dollar is the cornerstone of any Forex trading strategy. No other currency is present in such a number of pairs. In addition, it is the base currency of the commodities and US stock prices, so the effects of its fluctuations echo throughout the market.
In this lesson, you will understand why the world is so “dollarised” nowadays and why the most important market news is the changes in the economy and the monetary policy of the United States.
To begin with, the dollar has been called the “global reserve currency” since 1944. That year all the nations met in the United States at the Bretton Woods conference, which was intended to restore the international financial order after World War II.
Since most of Europe and Japan were devastated, the United States was able to benefit from this situation and significantly strengthen its own economy. Moreover, because of the war, many countries sent national gold to the United States for storage, which ultimately made America the strongest and wealthiest power of the time.
But even without this gold, America had the most significant precious metal reserves. This was an important aspect during the Bretton Woods talks since before the conference most countries have started to stick to the so-called “gold standard”.
However, the war changed everything, and this principle ceased to work.
Since the Bretton Woods Agreement, the countries have agreed to tie to gold the dollar exchange rate only, so their national currencies were pegged to the USD and the dollar continued its path to become the dominant reserve currency.
As it turned out, the agreement was just a promise.
It remained in effect for a couple of decades, and then it was terminated. The swift recovery of the European economies and the Vietnam War created adjustments: in 1971, countries around the world turned out to be holding dollars that were rapidly losing their value.USD is truly global and accepted all over the world, hence the importance of the American currency in the modern financial system. When it comes to foreign exchange reserves held by the world central banks, as well as the accounts of individuals, the share of dollars is about 55%, exceeding a total of $ 6.3 trillion.
For comparison, 3 times less money is stored in euro accounts all over the world, and 12 times less is in accounts denominated in yen and pound.
This situation contributes to the healthy demand for US currency in different countries of the world. This is a mutually reinforcing relationship: the US and dollar debt markets are the most liquid instruments, and for this, financial markets love them, because liquidity is an opportunity to buy and sell an asset without causing a price change. Just what central banks need to store the reserves!
In addition, the Fed (US Federal Reserve) is the most influential global central bank, often becoming the flagship of the monetary policy trends.
Why do people need dollars? They use them to hold their savings in case of weak or unstable local currency. In addition, the dollar is a universal means of international trade payments, as well as the base currency for the settlement to commodities, including gold and oil.
Let us explain why Oil is denominated in USD. After concluding an agreement between the American statesman Kissinger and Saudi Arabia, the Arab country agreed to sell its oil in dollars, in exchange for the US military protection in the region.
After this agreement, Saudi Arabia literally imposed its terms to the other OPEC countries (Organization of Petroleum Exporting Countries), and soon Brent began to be bought and sold only in US dollars.
There is also an observation that as soon as some countries wanted to change this order of things (for example, Iraq tried to switch to settlements in euros), they were subjected to the extremely aggressive pressure from America.
The same applies to Libya and Russia, although a formal pretext for the sanctions tightening and even an armed invasion invariably appeared after the desire to weaken the dollar hegemony.
Also, note that more than a third of the world debt (bonds) is issued in dollars.
Commercial banks and other legal entities issue debts to the local population, enterprises and other countries in USD as well.
Of course, the United States is aware that the influence of the dollar goes beyond the national economy. In the 1960s, the French Finance Minister noted that the USD “was content with the exorbitant privilege due to the demand for it as a reserve currency”. This also includes the influence of the American currency on the global financial markets. In general, a rising dollar is negative for raw materials and stock markets. In addition, its growth is often the precursor of capital outflows from such emerging markets as China, Russia, Mexico, South Africa, Turkey, etc.
At the end of the lesson, it is important to remember that the US Federal Reserve sets the interest rates and monetary policy not only to its own country but also to the global reserve currency (and, therefore, most of the world). At the same time, not only the local economy but also the global one is considered.
