Currency Wars and Fight for the World Reserve Currency

By Lawrence Gilbert

A world reserve currency is held in significant quantities by many governments and institutions as a means of international payment. Gold and silver were predominantly used prior to the Bretton Woods agreement, after which reserves included the US dollar. Being a world reserve currency has many benefits. The dollars status as a world reserve currency increases the demand for dollars globally. The price of dollars compared to other currencies, the exchange rate increases. The price of US goods is now more expensive to foreigners, compared to other goods, which reduces the demand for the higher priced US exports. However foreign goods are less expensive to US firms and households which in turn leads to increase in imports. The standard of living also increases substantially due to increasing demand for the dollar by countries to facilitate trade transactions.

One of the shaping instruments for the US to establish the dollar as a world reserve currency was the creation of the Federal Reserve in 1914. The outbreak of war in Europe during that time, lead to a financial crisis suffered by the European nations. During that period the American exports to Europe increased substantially to help in war efforts and basic commodities. America also played an important role in lending and providing financial aid to their Allies in Europe. As the war escalated, the role of the Federal Reserve assumed greater importance as a central bank and transformed the US dollar into a major international currency.

The federal reserve holding grew as more and more gold entered the country in exchange for US exports. At that time there was a gold standard, which means that every dollar was partially backed by gold. The federal reserve transformed these holdings into government securities which became an important monetary tool for the war. Purchase and sale of these securities, helped shaped the importance of the dollar and strengthened monetary policy. Increasing war expenses led to more dependence on the dollar, and the platform was already set for the dollar to become the dominant global currency. The British pound and European currencies became unstable and businessmen and traders turned to the dollar as the preferred medium of exchange.

After world war II, with the help of Bretton Woods agreements in 1945, the US dollar replaced the British pound sterling as the worlds reserve currency. The Bretton Woods agreements was an important landmark in shaping a world financial order, which led to the creation of the United Nations and the strengthening of other international organizations. The International Monetary Fund was set up to enforce a set of fixed exchange rates that were linked to the dollar. All other currencies were valued in terms of US dollars and thus were indirectly linked to the gold standard.

The gold-dollar standard which was prevalent, pegged the dollar at $35 per ounce of gold. This dollar linked by gold was the dominant world reserve stand for quite some time till 1971. However, due to the Vietnam war, there was an acute shortage of gold reserve in the US and hence the dollar conversion into gold was suspended. America's efforts and world events leading to the dollar becoming a world reserve currency is a very important factor in world politics and the global monetary system.

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