I recently found this article which explains this question in a easy way…thought it may be of interest to some of you in this group…
US Dollar Almighty
(Posted recently by Malaysian Author Mr. Syed Akbar Ali in his blog.)
Just to excite your interest (keep you from yawning) 'US Dollar Almighty' I will talk about the following:
i. Why is the US Dollar such an international currency, why is it so widely used and what is its future role?
To be widely accepted and to be successful, any currency must be perceived to represent value.In the beginning gold and silver were used as currencies. Whether they were used as currency or not, gold and silver carried their own value.
In the beginning (say in India in 6th century BC) gold and silver coins did not have 'token' values or face values. The weight of the coin was widely known, but there was no mention of how much 'money' it represented. So the monetary value of the coin could vary.
Later coins started having token values or face values higher than the amount of metal inside them, just like paper currencies today. This became 'fiat' money.But the more basic question is why gold ? Well the simple answer to that is because gold does not rust. You can burn it, melt it, blow it up or whatever but you can always put it back together again as a piece of gold and it would still be gold. Plus the fact that it is rare. You must dig up mountains to obtain gold.
There are other metals which are more expensive than gold and are also rarer - like uranium. But I think if we carried uranium coins in our pocket, we would start glowing quite embarrasingly. Gold has withstood the test of time.
In short, human beings need something that is dependable, something that will not disappear, something that is unchanging, something that is valuable. This is why human beings have given such high value to gold. This is a simple but very important point, please remember this because we will revisit this point when we come to see why the US Dollar is so succesful as an international currency. And plus the fact that gold is also rare - it became a perfect store of value and a medium of exchange, both rolled into one. You could store your wealth in the form of gold bars and gold jewellery in all shapes and sizes. Or you could use gold coins as money, a medium of exchange.
OK, not to bore you any longer. In my humble opinion, this is also exactly why the US Dollar, is perceived to have value, by almost the whole world. The US Dollar (also called 'greenback') is actually printed on cotton. The US Dollar represents a country, the United States of America (a country with 306 million people now?) which is perceived to be dependable, unchanging, has great 'economic' value and will not disappear anytime in the foreseeable future. Let me say something about the gold standard, the famous Bretton Woods agreement of 1944 and such. I really dont know what it all means. It has stopped functioning since 1971. The world has moved on quite well since then. During World War 2, even before the Bretton Woods agreement, the British Pound was pegged to the US Dollar and vice versa. In 1944, at the height of WW2, the Brits and the US met at a golf club in Bretton Woods, New Hampshire and agreed that their currencies, plus that of their wartinme allies, should have a fixed exchange rate. How would they achieve this? They would each hold gold in their central banks to back up their currencies. But this was not enough. Also at that time, the IMF and the IDRB (Int'l Bank for construction and Development - at that time mostly for orang putih sahaja because half the world was the British Empire and the other half was the French, Dutch, American and German empire) had also come into being. So they agreed that if any of the Bretton Woods countries had foreign exchange reserve problems, the IMF would extend emergency loans to that country.
Based on this agreement, and the safety net provided by the IMF and the IDRB, their exchange rates were kept stable - within a difference of 1% fluctuation only. But there were other more ridiculous aspects of Bretton Woods. Only the US Dollar could be converted into gold, the price of gold had to be maintained at a certain level and stuff. Quite impossible. Since 1865 (end of American Civil War), the US remains the most viable and robust nation on the surface of the earth. The fact that the US also has aircraft carriers, nuclear bombs and such are secondary. The US Dollar became a global currency even without these weapons of war. Compared to the US, as late as 1962, France was close to becoming a military dictatorship (the rebel 'colons' almost overthrew General DeGaulle). Around that time France also had to introduce a new currency, the 'new' French Franc. Spain was ruled by the dictator Generalissimo Francisco Franco from 1947 until 1975. Germany was divided and under constant threat of war until 1989. These are not exactly the conditions that build great confidence in your currency's international stature.Then just six years ago, in 2002 the Western European currencies disappeared and were replaced by the Euro, which was officially introduced in 1999. The Euro was physically launched in 2002 at parity with the US Dollar. But the Euro has now surpassed the US Dollar at 1.36:1. Why? Simply because the Euro zone (15 countries altogether?) is now the largest economic grouping in the world, with a combined GDP that exceeds the USD12.0 Trillion of the US.The Euro is not yet as popular as the US Dollar but it is geting there.
The US Dollar derives a lot of strength from the fact that many people around the world are reassured that as a country America is quite unshakeable and for the foreseeable future it will remain a rich, powerful and stable country. You can rely on the fact that when we wake up tomorrow America will still be around. This simply means that whether they like it or not, whether they agree or not, whether they are aware or not, people around the world still place their trust in the United States of America.
The point is, not only oil is priced in US Dollars but even the currencies of countries are valued in US Dollars. And the trade in foreign currencies is many times larger than the trade in oil. How many times larger? The trade in foreign Currencies is estimated to be USD2.0 Trillion PER DAY!! And most of this Forex trade is done in US Dollars. So that is how 'Almighty' the US Dollar is. Global oil trade is only a fraction of the currency trade. Then gold is also traded in US Dollars. But the greatest demand for US Dollars is between countries that export goods. Usually when a country exports goods, it wants payment in its own currency. When we export palm oil to Pakistan, we want to be paid in Ringgit, not in Pakistani Rupees. Therefore Pakistani importers must 'buy' our Ringgit (using their Rupees) and then give us the Ringgit in exchange for the palm oil. So technically the more we export, the more the demand for our Ringgit - hence our Ringgit will increase in value (or strengthen). But this is not always the case. Sometimes exporters do not want to be paid in the currencies of their home countries. For example in the 80sand 90s (and maybe even now) Indonesian exporters frequently wanted to be paid in US Dollars for their exports - not in their own Indonesian rupiahs. This is because their currency was suffering uncertainty -meaning fluctuation in value on a daily basis, instability etc.Or their country may be suffering increasing rates of inflation which may make their Rupiah earnings become smaller. So they want to bepaid in US Dollars which they will later convert to Rupiahs at a more opportune time. If their currency deteriorates further, they will exchange the US Dollars and get even more Rupiahs. So the US Dollar is going to be around for a while. The main reason is because America is a stable, rich, very progressive, extremely creative and productive country. And they are a democracy which values freedom. This is the underlying strength of the US Dollar. This is why the US Dollar is still Almighty. Just for your information, in the last week, despite the financial crisis, the US Dollar has strengthened against almost all world currencies except the Japanese Yen.
