Eli5: Why is the U.S. Dollar so powerful?
In: 208
Money is what you believe it to be. If too many believe its worthless, it will be.If many people believe in it, it will be valuable. A way to convert energy.
Diamonds, for example, are valuable because many believe them to be scarce.But in reality they are plentiful. Its called [artificial scarcity](https://thecuriouseconomist.com/are-diamonds-really-that-scarce/).
The US dollar is the currency that things like oil are traded in. This means that the US dollar is used a lot. Countries use the US dollar to buy oil from each other.
Any country that wants to stop this practice mysteriously has a coup backed by US dollars.
Because it reflects the physical safety of the United States as a country. It has energy-reserves, is surrounded and protected by two massive oceans its navy basically control, it has treaty allies, etcetc.
So, the US isn’t going to implode, or get into serious harm from external forces. You can’t say that about the countries or Unions representing other currencies such as the Euro or Yuan
I’m not a expert economist but from my understanding, there are multiple angles that make the USD so infamous and powerful.
What is money good for? Like seriously, it’s just a number on a paper (or computer screen these days). That’s basically worthless.
What makes it worth is that you can exchange that piece of paper (or whatever digial equivalent) for some real goods. Fruits, soybeans, clothes, machines, computer chips, buildings and also a lot of raw resources. Because without resources, you cannot produce anything. Amongst the resources, energy resources are of particular importance and oil is king. Oil is/was a resources for so many things it’s ridiculous. Apart from energy production (you, know which runs machines), it is also the raw ingredients for loads of actual chemicals. For almost half a century now, oil as a commodity has been traded in USD.
There is no particular reason for it really other than the US was first to establish this agreement by its political and industrial oil power status during the 20th century and everyone else used this agreement and traded oil in USD. So where do you get USD from then? Only the Federal Reserve of the US has the right to print/create new USD so the US is uniquely able to control the supply of USD on the world market that you can exchange for other things (for example oil, which literally everyone needed). To have the only levy in the world to create USD is a unique power noone else has.
And you know what else this implies? Everyone else has to buy USD to buy stuff but the US itself DOES NOT NEED to buy other currencies to buy for example oil or other things for imports – they use their own currency, which they print themselves. Isn’t that neat for the US? But for everyone else, it means you are uniquely dependent on something inherently out of your control.
Then you have the angle of the USD and its high weight in the SDR currency basket as well as being the most requested reserve currency in the world.
The SDR of the IMF is basically a virtual unit that is calculated by weighing different important currencies around the world. What is the SDR useful for?
A lot of settlements in international shipping that transport goods around the world and a lot of other things that are connected to the IMF are using SDR for accounting. The USD is the heavyweight amongst the currencies, accounting for currently around 43% of the basket composition. Meaning anyone that has control of the USD supply has an enormous influence on the calculation of this basket and thus everything connect to it.
Then you have the reserve currency thing: There are a basket of foreign reserve currencies but among them, things valued in USD are with a large discrepancy the main currrency that central banks around the world hold assets in.
The USD is currently standing at around 59% according to IMF COFER reports from Q4 2021, meaning across all important central banks around the world, an average of 59% of foreign exchange reserves are in USD.
Why is that important? Foreign exchange reserve can serve a variety of purposes (especially for developing countries). One of the important things is that you can stabilize your own national currency with it. You can spent a load of USD to buy your own currency on the world market, releasing a lot of USD while simultaneously short your own currency supply so the exchange rate rises.
Another important fact is that you can service your own external debt with foreign exchange reserves in USD. The US has been known to reliably service it’s debtors, meaning if I give you 25 papers saying ‘With this paper, you can retrieve X amount of USD from the US Federal reserve in 6 months’ that I purchased a couple of months ago, you’ll get that amount guaranteed. So my debt to you is settled.
But the US in itself has no such thing as a ‘foreign exchange reserve crisis’ which can often turn into a national currency crisis in developing countries…to whom exactly would the US have a currency crisis caused by an ‘implausibly low amount of foreign exchange to prop your own currency’? They themselves are in control of the most important foreign exchange reserve currency, the USD!
Well. You see, you’re only allowed to buy oil by the barrel. In American dollars.
When you try to buy it using some other currency…unfortunate events seem to happen to you. Purely happenstance, of course, but it has made nations superstitious and thus it artificially reinforced the value of the dollar on the world exchange.
Enforcement of the petro dollar. If you try to trade oil without the US dollar, you end up with weapons of mass destruction in your backyard and CIA topples your goverment.
The USA doens’t produce much of the global oil, throughout history since WW II, but global oil has always been traded in dollars.
This has kept the dollar valuable, you could always buy oil from it. There has been many times countries have said, why don’t we sell our oil in our local currency, but essentially, USA then destroys them.
Isn’t there something about the gold standard and how they just started printing money willy nilly in the 70’s?
It’s literally a fiction. US Dollar is an asset based-currency. It’s not supported by tangible things. That’s why it will crumble apart.
Because of it’s perceived safety compared to other currencies. The recent seizure of Russian reserves has upended that perceived safety.
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