A global currency is one that is accepted for trade throughout the world. Some of the world’s currencies are accepted for most international transactions. The most popular are the U.S. dollar, the euro, and the yen. According to the International Monetary Fund, the U.S. dollar is the most popular. So how exactly did this become so powerful?
Dollar makes up over 60% of all known central bank foreign exchange reserves. More than $1.8 trillion of U.S. currency is now in circulation around the world, and it’s believed that two-thirds of $100 bills and nearly half of $50 bills are held outside the US. The next closest reserve currency is the euro. It makes up 20% of known central bank foreign currency reserves.
The relative strength of the U.S. economy supports the value of the dollar. It’s the reason the dollar is the most powerful currency. As of 2018, the U.S. had $1,671 billion in circulation. As much as half that value is estimated to be in circulation abroad. Many of these bills are in the former Soviet Union countries and in Latin America. They are often used as hard currency in day-to-day transactions.
In the foreign exchange market, the dollar rules. Around 90% of forex trading involves the U.S. dollar. The dollar is just one of the world’s 185 currencies according to the International Standards Organization List, but most of these currencies are only used inside their own countries.
Almost 40% of the world’s debt is issued in dollars. As a result, foreign banks need a lot of dollars to conduct business. This became evident during the 2008 financial crisis. Non-American banks had $27 trillion in international liabilities denominated in foreign currencies. Of that, $18 trillion was in U.S. dollars. As a result, the U.S. Federal Reserve had to increase its dollar swap line. That was the only way to keep the world’s banks from running out of dollars.
The financial crisis made the dollar even more widely used. In 2018, the banks of Germany, France, and Great Britain held more liabilities denominated in dollars than in their own currencies. Additionally, bank regulations enacted to prevent another crisis have made dollars scarce, and the Federal Reserve has increased the fed funds rate. That decreases the money supply by making dollars more expensive to borrow.
The dollar’s strength is the reason governments are willing to hold the dollar in their foreign exchange reserves. Governments acquire currencies from their international transactions. They also receive them from domestic businesses and travelers who redeem them for local currencies.
Some governments invest their reserves in foreign currencies. China and Japan deliberately buy the currencies of their main export partners. The United States is the largest export partner in China, and second-largest in Japan. They try to keep their currencies cheaper in comparison so their exports are competitively priced.