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Wednesday, September 22, 2021

What makes the greenback the “global currency” – and why keep an eye on it? 

The US dollar is undoubtedly the world’s “global currency.” Not only is it the most recognized of all the world’s currencies, but it’s also one of the most powerful. Forex traders across the world keep a close eye on the movements of the US dollar, and that goes for whether they are trading the greenback or not.  

But what gives the greenback this unusual status in the forex trading world? There are various factors involved in the development of this status, and it’s worth thinking closely about what each of these are, even if you’re not invested in the dollar. This article will delve into these explanations.   

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History: Bretton Woods Agreement 

While the US dollar’s dominance in the modern-day appears on the face of it to simply be the product of lots of relatively recent forces, the reality is that the dollar’s position was entrenched by an agreement made decades ago. As the Second World War was ending, it became apparent to world leaders that a new system of managing foreign exchange services was required to make sure that the Allies in the West did not leave any of their number out in the cold.  

The Bretton Woods Agreement was the consequence. Rather than pegging the value of global currencies to the commodity of gold, which had happened before and was known as the “gold standard,” currencies could be pegged to the value of the dollar. The dollar itself was pegged to gold, so there was still some link. And the Allies could, as a result, sell US dollars back to the US and receive gold – although, in return, the central banks of the other countries had to cement the exchange rate between their own currency and the greenback.  

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The long-term result was that the US dollar created built-in institutional dominance. Countries were suddenly incentivized to have large stocks of US dollars in the background instead of hordes of gold – meaning that demand for the dollar and US Treasury securities went through the roof. 

Fast forward: today

The words “Bretton Woods” are rarely on people’s lips anymore, but the effects of that historic agreement live on. Central bank reserves worldwide are often structured around the US dollar: well over 60% of global foreign banks have their reserves in US dollars. These are usually either in pure cash or in bonds linked to the value of the dollar. And it’s also the case that a big chunk – although not a majority – of global debt is in US dollars, too.  

The role of the US economy

But the historical forces that led from the Bretton Woods agreement to the current system of central bank reserves are not all that’s relevant here. It’s also the case that the strength of the US economy comes into play in several ways. On a surface level, information about the size of the US economy leads many traders to think it’s almost unassailable when it comes to trust and confidence. With a nominal gross domestic product (GDP) of $21.43trn and a GDP per capita of $65,298, few countries around the world can hold a candle to it. To forex traders, these sorts of statistics suggest that there will always be inward supply when it comes to business investment in the US, and the knock-on effects for the currency are clear.   

But there are deeper economic reasons why the US dollar remains so trusted. Businesses and governments want to be sure that their debts will be repaid if they enter into contracts with a country’s economy, and the high levels of confidence in and demand for the US dollar suggest that the country is unlikely to go insolvent any time soon. What’s remarkable to many analysts is that this perception persists even though the US is a heavily indebted nation. It has embarked on some large spending packages in recent years – not least when it comes to schemes like the coronavirus response packages. 

What does it mean for a trader? 

For traders, then, it’s clear that the dollar’s performance must never be ignored. When the dollar moves, so does the world economy – and the whole forex market can be affected by what the dollar is doing. While movements in the foreign exchange markets can’t be predicted with certainty, it’s often the case that the dollar rises in the event of global uncertainty as traders seek to consolidate their holdings into a currency that can be easily redeemed for cash. When the market is less risk-averse, the demand for the dollar – and hence its value – tends to drop.  

If you trade the dollar as part of your pairs, this is important to monitor. But even if you don’t, it’s still vital to keep an eye on the dollar’s performance. It can speak to the underlying health of the broader forex market and the wider global economy – and, as a trader, these are two trends you need to monitor. A good broker, such as those recommended for their Forex Safety levels by a reputable site like ForexFraud, ought to have a range of tools available to monitor the dollar on both a technical and fundamental basis. 

In short, the US dollar has the forces of both history and the present day on its side when it comes to establishing and preserving its place as the world’s leading currency name. The Bretton Woods Agreement established the greenback as the world’s reserve currency, and the currency later went on to persist in its strength. In the present day, the fact that the dollar is linked to one of the world’s most successful economies gives it a level of trust that very few, if any, other currencies can claim.  

 

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