I’m an economics graduate but I can’t seem to find the answer to my own question. May be because I was absent or not paying attention to the professor when it was lectured. Or may be it’s not found in any of the books. I’ve been wondering about this for a very long long long time.
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If you go back to any time between 1950 and 1985, what were the alternatives? The Euro didn’t yet exist. The Yen was about 350 to US$1. The Chinese Renminbi wasn’t yet widely traded. The USSR Ruble? Puh-LEEEZE! The UK Pound, the (West) German Deutsche Mark and the Swiss Franc were all strong currencies, but the US economy was several times larger than any of them.
Of course, in 29, some of that is no longer true. The Euro represents an economy nearly the size of the US. However, the costs involved in switching to a different currency for international trade would make for a bookkeeping nightmare, at least for now. The dollar would have to weaken considerably for that to change.
Obviously , the dollar hasn’t always been the unit of currency since it didn’t exist a few hundred years ago but there are several reasons why it is now. For one, the US had the worlds largest single currency economy which meant more dollars were in circulation and being held by foreign banks, companies, etc. Two is that it’s somewhat just a matter of convenience. You had to pick a standard that the international community had confidence in so you might as use the one largest one. Lastly, as the US economy began to become a larger part of the world economy, countries began to enter into agreements with each other for currency exchange. If two different counties already had an agreement with the US, then they night as well extend that to each other to deal in dollars. Obviously, it’s more complicated than what I’ve written but this is essentially the reasoning behind it.
As for this always being the case, there have been recent times when other currencies were considered almost as common as the dollar,,, the Japanese Yen and German Mark gained prominence in the ’70’s and ’80’s. More recently, the Euro is used but probably the next international currency will be the Chinese Yuan.
Here’s an article that explains this in greater detail. It’s from ’98 and is mostly about the dollar and the Euro but it discusses some of the reasoning.
Another way to look at things.
If you produce tonnes & tonnes of oil, wheat, metals, beef, tv’s.. or any commodity, what would you rather be paid in?
Would you really want to be paid in Rubles, Euro’s, Yuan, or gold? You would just have to turn these back into US dollars to go and buy the stuff that you need.
Let’s say you make cars. you need to buy all the components, put them together, then sell them for a profit. Now think about how you are going to trade. To maximise your profit potential, you want to be able to do this efficiently as possible & you also need to manage you currency risk – there is no point buying lots of components with one or a mix of currencies if you can’t sell the end product at a profit.
The market largely decides which currency it wants to use. And they have chosen to use US dollars.
Painful as it is for some to politically accept – the US economy is actually the most respected market place in the world – contracts are honored, the currency is generally well managed, the market place is mostly free from government interference and cronyism.
Source(s): www.thedailytradingreport.com