Michael Congdon, CEO, CCO
Sitting at my desk yesterday looking at a chart of the US Dollar index, I realized many people might not know the history of how the United States Dollar became the world’s reserve currency. With Independence Day coming up on July 4th , I thought it would be the perfect time to share a little bit of the history of currency in the United States and how the US Dollar became the world's reserve currency.
The First Paper Currency (1)
The first documented use of paper currency in the United States was in 1690, when colonial notes were issued by the Massachusetts Bay Colony to fund military expeditions. Other colonies quickly followed suit and began issuing paper notes. Many years later, on June 15th, 1776, the Continental Congress authorized issuance of two dollar notes as ‘bills of credit’ for the defense of America. Nine years later, in 1785, the United States officially adopted the dollar sign – a symbol evolved from the Spanish-American figure for pesos.
Skipping forward to 1863, the Office of the Comptroller of the Currency and the National Currency Bureau were established to handle issuing new banknotes. Money was printed by private companies up until 1869 when the Bureau of Engraving and Printing was given that assignment.
The US Treasury assumed the responsibility of issuing legal tender in 1890, over twenty years before the creation of the Federal Reserve and the dollar as we know it today.
The Gold Standard
The Federal Reserve Act of 1913 created the Federal Reserve Bank to establish economic stability in the United States by introducing a central bank to oversee monetary policy. At the time, the US economy was starting to become the world’s largest, edging past the United Kingdom. Internationally, commerce still was centered around the UK with most transactions taking place in British Pounds.
Most countries pegged their currencies to gold to stabilize currency exchanges. When World War I broke out in 1914, many countries suspended their use of the gold standard to pay their expenses with paper money, devaluing their currencies as a result. Britain held to the gold standard to maintain its position as the world's leading currency, and by the third year of the war found itself borrowing money for the first time.(2)
The United States became the lender of choice for countries that wanted to by dollar-denominated US bonds. Britain abandoned the gold standard in 1931, which decimated the bank accounts of international merchants who traded in British Pounds. The dollar replaced the pound as the leading international reserve currency.(3)
The Bretton Woods Agreement
After the United States entered World War II, they served as the Allies’ main supplier of weapons and other goods. Most countries paid in gold leading to the US being the majority holder of the world's gold by the end of the war. This made a return to the gold standard impossible for the countries who depleted their reserves.(4)
Delegates from 44 allied countries met in Bretton Wood, New Hampshire in 1944 to develop a system to manage foreign exchange that would not disadvantage any individual country. They decided that the world’s currencies would no longer be linked to gold but could be pegged to the US Dollar. That worked because the US Dollar itself was linked to gold.(5)
The arrangement came to be known as the Bretton Woods Agreement. It established the authority of central banks, which would maintain fixed exchange rates between their currencies and the dollar. In turn, the United States would redeem US dollars for gold on demand. Countries had some degree of control over currencies in situations wherein the values of their own currencies became too weak or too strong relative to the dollar. They could buy or sell their currency to regulate the money supply.
The US Dollar Becomes the World’s Reserve Currency
The US dollar was officially crowned the world’s reserve currency and was backed by the world’s largest gold reserves thanks to the Bretton Woods Agreement. Instead of gold reserves, other countries accumulated reserves of US dollars. Needing a place to store their dollars, countries began buying US Treasury securities, which they considered to be a safe store of money.
The demand for Treasury securities, coupled with the deficit spending needed to finance the Vietnam War and the Great Society domestic programs, caused the United States to flood the market with paper money. With growing concerns over the stability of the dollar, the countries began to convert dollar reserves into gold.(6)
The demand for gold was so high that President Richard Nixon was forced to intervene and de-link the dollar from gold, which led to the floating exchange rates that exist today. Although there have been periods of stagflation, which is defined as high inflation and high unemployment, the US dollar has remained the world’s reserve currency.
The U.S. Dollar Today
The dollar remains the world's reserve currency today. Central banks hold around 59% of their reserves in US dollars, according to the International Monetary Fund (IMF).(7) Many of the reserves are in cash or U.S bonds, such as U.S. Treasuries. Dollar-denominated debt outside the US continues to rise, with levels reaching $13.4 trillion as of mid-2022.(8)
The reserve status of the US Dollar is based largely on the size and strength of the US economy financial markets. Despite large deficit spending, trillions of dollars in debt, and the unbridled printing of US dollars, US Treasury securities remain the safest way to store money. The trust and confidence that the world has in the ability of the United States to pay its debts keep the dollar as the most redeemable currency for international commerce.
(2) Federal Reserve Bank of St. Louis. "The International Gold Standard and U.S. Monetary Policy from World War I to the New Deal," Pages 1-2.
(3) National Bureau of Economic Research. "The Rise and Fall of the Dollar, or When Did the Dollar Replace Sterling as the Leading International Currency?"
(4) Federal Reserve Bank of St. Louis. “The Changing Relationship between Trade and America’s Gold Reserves”
(5) Federal Reserve History. "Creation of the Bretton Woods System."
(6) Council on Foreign Relations. "The National Debt Dilemma."
(7) International Monetary Fund Blog. "Dollar Dominance and the Rise of Nontraditional Reserve Currencies."
(8) Council on Foreign Relations. "The Dollar: The World's Currency."