What makes the US dollar so strong?

Today, the US dollar (USD) is the most prominent currency in the world. This is tied to the fact that the US has the largest economy in the world, along with the dollar’s use globally.

Not only is it commonly exchanged outside the US, but several nations have tied their currencies to the dollar or adopted it as their official currency.

Here’s how the dollar grew to be such a force in the global economy.

Why is the US dollar so strong?

The dollar’s value comes from the US’ position as a critical global economic power and the country's political and economic stability.

While it may hold less value than such currencies as the Swiss franc or the British pound, the dollar’s global use makes it a more commercially viable currency.

Plus, economic or political disturbances can cause a currency’s value to change suddenly. Venezuela is a recent example: financial trouble and political instability have led the value of its domestic currency, the Bolivar, to drop from 10.4 Bolivars per USD in 2017 to 236,266.5 Bolivars per USD in 2020.

In contrast, due to its diverse economy and strong political institutions, the US can survive periods of poor economic growth, such as a recession. This makes the country an ideal place for financial investment and trade, further strengthening the demand for the USD.

Another key factor to the dollar’s relative strength is the Federal Reserve, which sets interest rates to avoid high inflation and maintain economic stability. Keeping inflation rates low (the Fed aims for a long-run annual rate of 2%) prevents the dollar from losing too much value over time.

The global role of the US dollar

The prevalence of the USD in every major economy means most nations use the currency to buy and sell goods worldwide.

For example, if South Korea exports goods to Brazil, the two countries might simplify the transaction by using USD rather than their respective currencies.

In 2022, about half of international trade was exchanged in US dollars, as were about half of all international loans and debt securities, according to the Congressional Research Service.

Citizens of foreign nations often use the US dollar to buy goods and services in their country rather than use their domestic currency.^[1] As of March 2021, nearly half of all US banknotes were held by foreign citizens, amounting to roughly $950 billion.

The dollar’s role as the leading global currency stems from actions taken nearly 80 years ago.

After WWII, the US was in a better economic condition than any other country. This economic prosperity helped make the dollar the world’s strongest currency, meaning it was more valuable than any other international currency at the time.

The Bretton Woods Conference further secured this position when 44 nations agreed upon a set of rules placing the US dollar at the center of the new global economy.

Under this arrangement, most other currencies were pegged to the dollar, making their value depend on the USD’s value.^[2] Demand for the US dollar rose to unprecedented levels as a result.

One way to measure the dollar’s pivotal role in the global economy is its share in international reserve currencies. A reserve currency is a currency held by central banks worldwide and used to conduct trade deals, financial transactions, and other forms of monetary policy. Since WWII, the US dollar has been the world’s dominant reserve currency, meaning most other nations around the world use the dollar to carry out economic policies.

Seven countries have adopted the USD as their official currency due partly to its reliability in international markets.^[3] Several other countries still have their currencies fixed to the dollar at varying levels for various reasons.

While these factors strengthen the dollar’s value, there can be drawbacks to having such a dominant currency.

What are the potential problems of a strong US dollar?

A strong dollar makes it harder for US producers to sell goods abroad since countries with weaker currencies can produce goods more cheaply. It also means people can import goods from abroad more cheaply. This is one of the reasons the US has been in a trade deficit since the 1970s.^[4]

America’s central position in the world economy also means that almost every other nation’s economic success is partially tied to the US. If the US dollar suddenly lost value due to an event like a recession, every country relying on it could experience economic disruption.

This is partly what occurred after the 2008 Financial Crisis when global stocks fell by more than 40% following the US housing market crash.

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