Download Why does the World use US Currency as their main trading currency

Why does the World use the dollar Currency as their main
trading currency?
Origins of a Unified Money System. The Bretton Woods system of money
management established the rules for commercial and financial relations among the
world's major industrial states in the mid-20th century. The Bretton Woods system was
the first example of a fully negotiated monetary order intended to control monetary
relations among independent nation-states.
730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel in
Bretton Woods, New Hampshire, for the United Nations Monetary and Financial
Conference. They were preparing to rebuild the international economic system as World
War II was still being fought. The delegates deliberated during 1–22 July 1944, and
signed the Agreement on its final day.
Setting up a system of rules, institutions, and procedures to regulate the international
monetary system, the planners at Bretton Woods established the International Monetary
Fund (IMF) and the International Bank for Reconstruction and Development (IBRD),
which today is part of the World Bank Group. These organizations became operational in
1945 after a sufficient number of countries had ratified the agreement.
The chief features of the Bretton Woods system were an obligation for each country to
adopt a monetary policy that maintained the exchange rate by tying its currency to the
U.S. dollar and the ability of the IMF to bridge temporary imbalances of payments.
Nations used the gold standard from the 1880’s to 1931. When a nation imported goods,
their money would be out in the international sphere, making it worth less. They would
have to slow imports and people would purchase goods from them (their goods would be
cheaper) and the gold standard system was supposed to self-regulate. For several
reasons, America acquired more gold than all of the rest of the world combined in the
1920’s. This imbalance led to the Great Depression and the end of the gold standard.
Free trade relied on the free convertibility of currencies (exchange one currency for
another, or for gold). Negotiators at the Bretton Woods conference, fresh from what they
perceived as a disastrous experience with floating rates in the 1930s, concluded that
major monetary fluctuations could stall the free flow of trade.
The new economic system required an accepted vehicle for investment, trade, and
payments. Unlike national economies, however, the international economy lacks a central
government that can issue currency and manage its use. In the past this problem had been
solved through the gold standard, but the architects of Bretton Woods did not consider
this option feasible for the postwar political economy. Instead, they set up a system of
fixed exchange rates managed by a series of newly created international institutions using
the U.S. dollar (which was a currency backed by gold, for central banks) as a reserve
currency. (All other currencies tied their money value to that of the US dollar)
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Why did we go off of the Gold Standard and why do we have so much inflation?
On 15 August 1971, the United States unilaterally terminated convertibility of the dollar
to gold. This brought the Bretton Woods system to an end and saw the dollar become fiat
currency. This action, referred to as the Nixon shock, created the situation in which the
United States dollar became a reserve currency used by many states. At the same time,
many fixed currencies (such as the British Pound, for example), also became free
floating. By the early 1970s, as the costs of the Vietnam War, the Cold War and
increased domestic spending on the Great Society accelerated inflation,[3] the U.S. was
running a balance-of-payments deficit and a trade deficit.
By 1971, America's gold stock had fallen to $10 billion, half its 1960 level. Foreign
banks held many more dollars than the U.S. held gold, leaving the U.S. vulnerable to a
run on its gold. At the time, the U.S. also had unemployment and inflation rates of 6.1%
and 5.84% respectively.
To prevent a run on the dollar, stabilize the economy, and decrease unemployment and
inflation rates, on August 15, 1971, Nixon issued Executive Order 11615, pursuant to the
Economic Stabilization Act of 1970, which imposed a 90-day maximum wage and price
ceiling, a 10% import surcharge, and, most importantly, "closed the gold window",
ending convertibility between U.S. dollars and gold.
Later ramifications
The Nixon Shock has been widely considered to be a political success, but an economic
nightmare, in bringing on the stagflation of the 1970s and leading to the instability of
floating currencies. The dollar value plunged by a third during the '70s, and in 1997
several Asian and Latin countries faced currency crises. Even to the present, Paul
Volcker regrets the abandonment of Bretton Woods. "Nobody's in charge," Volcker says.
"The Europeans couldn't live with the uncertainty and made their own currency and now
that's in trouble."
In 1996, Paul Krugman summarized the post-Nixon Shock era as follows:
The current world monetary system assigns no special role to gold; indeed, the Federal
Reserve is not obliged to tie the dollar to anything. It can print as much or as little money
as it deems appropriate.
There are powerful advantages to such an unconstrained system. Above all, the Fed is
free to respond to actual or threatened recessions by pumping in money. To take only one
example, that flexibility is the reason the stock market crash of 1987—which started out
every bit as frightening as that of 1929—did not cause a slump in the real economy.
While a free-floating national money has advantages, it also has risks. For one thing, it
can create uncertainties for international traders and investors.
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Over the past five years, the dollar has been worth as much as 120 yen and as little as 80.
The costs of this volatility are hard to measure but they must be significant. Furthermore,
a system that leaves monetary managers free to do good also leaves them free to be
irresponsible—and, in some countries, they have been quick to take the opportunity.
Debate over the Nixon Shock has persisted to the present day, with economists and
politicians across the political spectrum trying to make sense of the Nixon Shock and its
impact on monetary policy in the light of the recent financial crises. Conservative
columnist David Frum sums up the situation this way:
The modern currency float has its problems. There is no magical monetary cure,
monetary policy is a policy area almost uniquely crowded with trade-offs and lesser evils.
 If you want a classical gold standard, you get chronic deflation punctuated by
depressions, as the U.S. did between 1873 and 1934.
 If you want a regime of managed currencies tethered to gold, you get regulations
and controls, as the U.S. got from 1934 through 1971.
 If you let the currency float, you get chronic inflation punctuated by bubbles, the
American lot since 1971.
System 1 is incompatible with democracy, because voters won’t accept the pain inherent
in a gold standard and vote out politicians even though it might not be their fault.
System 2 is incompatible with the free market economics I favor because it has controls
inconsistent with a free market.
That leaves me with System 3 as the worst option except for all the others.
Sources: Wikipedia, Cliffs Quick Review of Economics,
http://fraser.stlouisfed.org/publication/?pid=430
Kannapel, Charles: Ramifications of the Nixon Shock, 2016
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