28 Why Does the US Dollar Dominate the World? What Power Made It the Reserve Currency?
A lot of people ask the same question: Why is the US dollar the world’s reserve currency? Why is it that the entire global economy is so dependent on one country’s monetary policies and liquidity strategies? Is this a normal situation?
Let’s start with the basics. Earlier, we discussed that for something to function as money, it needs to fulfill certain roles. It’s not enough to just take a piece of paper, write numbers on it, sign your name, and call it money. For it to work, other people must recognise it as a medium of exchange, a store of value, and a unit of account. If people accept it for transactions and believe in its value, then congratulations – you have created money!
This is exactly what happened with the US dollar on a global scale. Over time, trust in the dollar grew to the point that it became the dominant currency for trade, finance, and global transactions. But why the US dollar specifically? That’s where history, economic power, and financial stability come into play.
Many national currencies lose their functionality once they cross borders. While they may work perfectly within their home country, outside of it, they often become useless or extremely inconvenient. To understand why, let’s revisit one of the core functions of money: being a unit of account, meaning it is used for pricing goods and services.
Earlier in this book, we discussed how, in a chaotic setting like a prisoner-of-war camp, cigarettes became the standard for pricing goods because everyone understood and accepted their value. This happened because money, at its core, needs to be widely recognised to function effectively.
Now, apply this idea to the global economy. If every country priced goods in its own currency, it would create confusion. Businesses would need to constantly update price lists in dozens of currencies, and buyers would always have to calculate exchange rates before making a purchase. Imagine walking into a shop in a foreign country where every price tag is in an unfamiliar currency – you’d have to stop and ask, ‘How much is this in a currency I actually understand?
This challenge is even greater in countries where a single US dollar is worth hundreds of thousands or even millions of units of local currency. For example, in Iran, as of recent years, 1 US dollar has been worth hundreds of thousands of Iranian rials. In Venezuela, during periods of hyperinflation, the exchange rate reached absurd levels, with 1 US dollar being worth millions or even billions of bolívares at certain points. Imagine if a major international company, like Apple or Toyota, decided to price its products in Venezuelan bolívares or Iranian rials.
A car that costs $30,000 in the US would be priced in the trillions of bolívares in Venezuela, with a price tag so long it might not even fit on a receipt! Everyday transactions would become impractical, requiring businesses to continuously adjust prices to keep up with inflation and currency depreciation. Employees would struggle to calculate exchange rates accurately, and financial records would become cluttered with enormous, ever-changing numbers.
This is exactly why international trade operates in stable and widely accepted currencies like the US dollar. It simplifies transactions, ensures price stability, and allows businesses to plan ahead without worrying about exchange rate chaos. Without a common currency for pricing, global trade would be a logistical nightmare.
Now, let’s consider another key function of money: being a medium of exchange, meaning it is used for transactions and trade.
Imagine doing business with a company in a politically unstable country – one where anything could happen overnight. A place where the government might suddenly collapse, the military could take control in a midnight coup, or democracy could be suspended indefinitely. This is a country with poor human rights records, weak institutions, and unpredictable leadership. Now, suppose you sell products to a company in this country, and they agree to pay you in instalments over time.
They ask you, Would you like to be paid in our local currency or in US dollars? What would you say?
Of course, you would never accept their local currency. With so much uncertainty, their currency could lose half its value overnight due to political turmoil or economic mismanagement. By the time they make their next payment, the money you receive could be worth far less than when you signed the contract.
Now, what if you ask them to pay in your own country’s currency? That’s another problem. How would a company on the other side of the world even get hold of your currency? Unless your country’s currency is widely used internationally, they would have to go through a complicated and costly process to exchange it first.
And so, in global trade, transactions naturally gravitate toward widely accepted, stable currencies. This is why payments between companies in different countries overwhelmingly use the US dollar or, in some cases, the euro. The US dollar alone accounts for 60-70% of global trade transactions, with even higher percentages in some regions. While other currencies are used in certain parts of the world, the dominance of the dollar in cross-border payments remains unmatched.
Even the European Union, with its common currency, the euro, has not been able to break the dominance of the US dollar in global trade and finance. Despite being one of the world’s largest economic blocs, the euro accounts for only about 20% of international transactions, far behind the US dollar.
Now, think about this – the European Union’s total economic size is roughly equal to that of the United States. It consists of 27 countries, many of which are highly developed economies. So why hasn’t the euro emerged as a true alternative to the dollar? The answer lies in market confidence and the fear of uncertainty.
Even a small element of unpredictability can make investors and businesses hesitate to fully rely on a currency. The eurozone has seen its share of instability. Imagine if you had structured all your financial dealings in euros, and then – suddenly – the UK voted to leave the European Union. Brexit instantly created a wave of uncertainty, shaking confidence in the long-term stability of the European project.
The United States, by contrast, offers a different kind of stability. In many ways, it is similar to the EU -a large, integrated economy with different regions (or states). But think about it this way: imagine if California suddenly announced it was leaving the US. That would be equivalent to a major EU country leaving the bloc. Sounds almost unthinkable, right? Unlike the European Union, the US is a political and monetary union that feels far more permanent.
This is why markets continue to prefer the US dollar over the euro for global transactions. The euro is strong, but even a small amount of uncertainty is enough for businesses and investors to stick with what they trust the most – and for now, that remains the US dollar.
The United States continues to dominate as the world’s reserve currency because it remains unrivaled in key areas: technology, science, and military power. As long as the US maintains its global influence in these domains, the dollar’s status as the dominant international currency remains unchallenged.
Recognising this advantage, the US took a bold step in the 20th century that forever changed the global financial system. Before this shift, international currencies were backed by gold reserves, meaning that every unit of currency issued had to be backed by an equivalent amount of gold stored in central banks. If you looked at an old banknote (these banknotes no longer exist), it would say something like, “This note is redeemable for gold at the central bank.” In theory, this meant that anyone holding paper money could walk into a bank and exchange it for a fixed amount of gold.
However, in 1971, under President Richard Nixon, the US decided to abandon this system altogether, an event now known as the Nixon Shock. Before this, under the Bretton Woods Agreement (1944), most of the world’s currencies were pegged to the US dollar, which itself was tied to gold at a fixed rate of $35 per ounce. This system provided stability but also restricted how much money governments could issue since they needed enough gold to back it up.
The US, seeing its economic power and the global trust in the dollar, decided it no longer needed to be constrained by gold reserves. By severing this link, it effectively declared: Our currency is valuable not because of gold but because of the strength of our economy. This move meant that the US could now print as much money as it wanted without being limited by gold reserves, allowing it greater flexibility in managing economic growth, inflation, and financial crises.
While this decision was controversial, it ultimately worked in America’s favour. The world continued to trust the US economy and military dominance, so the dollar remained the most widely used and accepted currency in global trade, finance, and central bank reserves. The fact that other countries did not abandon the dollar after the gold standard ended proved how deeply embedded it had become in the global financial system.
Today, no one walks into a central bank demanding to exchange paper money for gold. That system is long gone. But the legacy of the US dollar as the global reserve currency continues, not because of physical gold, but because of the confidence that the world places in the economic, political, and military strength of the United States.
After the US ended the gold standard, it fully embraced the power of the dollar as the world’s reserve currency. It recognised that rather than tying the global financial system to gold, it could tie it to the US dollar and the policies of the Federal Reserve (the American central bank). This decision fundamentally reshaped the global economy.
From that moment on, financial markets worldwide became dependent on the US dollar and the decisions made by the Federal Reserve. Unlike before, when countries had to manage their economies based on gold reserves, now they had to react to the monetary policies of the US. The global financial system no longer revolved around a scarce commodity like gold – it revolved around the actions and decisions of the US central bank.
This is why the Federal Reserve’s interest rate decisions affect the entire world. If the Fed lowers interest rates, it stimulates economic growth globally – borrowing becomes cheaper, investment increases, and capital flows more easily to emerging markets. On the other hand, if the Fed raises interest rates, it strengthens the dollar, making it more attractive for investors. This immediately impacts other currencies, causing capital to flow out of emerging economies and back into the US. Countries around the world, even those that have nothing to do with the US directly, feel the impact through inflation, investment flows, and exchange rate fluctuations.
In simple terms, the world’s financial system today is not just based on the US dollar – it is governed by the Federal Reserve’s decisions. This means that even if you live in a country far from the US, the Fed’s policies still shape your economy, the cost of borrowing, inflation levels, and even job markets. Whether the Fed raises or lowers interest rates is not just an American issue – it is a global event that immediately ripples through economies everywhere.
Despite the dominance of the US dollar, some countries have attempted to form alliances to trade using their own currencies, aiming to reduce their dependence on the dollar. The idea is simple: instead of using the US dollar as an intermediary, they propose trading directly in their national currencies. However, in practice, these efforts have largely ended in failure.
Take the BRICS nations (Brazil, Russia, India, China, and South Africa), for example. These five countries have long discussed creating an alternative to the dollar for trade among themselves. Russia and China, in particular, have pushed for using their own currencies in bilateral trade agreements. While some trade in yuan and rubles has increased, the overall success has been limited. Most international contracts – including those between BRICS countries – still rely on the US dollar because it remains far more stable, liquid, and widely accepted. Even within BRICS, members have struggled to fully trust each other’s currencies due to economic and political instability in some of the bloc’s nations.
Another attempt at breaking away from dollar dependence came from countries like Iran and Venezuela, both of which have been heavily sanctioned by the US. These nations have tried to trade with allies using alternative payment systems, including barter agreements, cryptocurrencies, and non-dollar currency swaps. But these strategies have not been enough to replace the convenience and reliability of the dollar. When businesses and governments need stability and security, they return to the currency they trust the most – and for now, that is still the US dollar.
Even the European Union, one of the world’s largest economic powers, has struggled to compete with the dollar in international transactions. Despite having a common currency, the euro, the EU has faced challenges in fully replacing the dollar as the global reserve. One major reason is political fragmentation – even though the EU operates as a single market, it consists of 27 independent nations, each with different economic policies, regulations, and long-term priorities. The uncertainty created by events like Brexit, or even internal disputes within the EU, makes the euro less attractive as a global alternative.
Now, if a highly developed, politically stable, and economically powerful region like the EU struggles to reduce dollar dependence, imagine how much harder it is for a small group of politically unstable, economically volatile countries to form an alternative. The harsh reality is that countries that cannot even guarantee stability for their own currencies are unlikely to convince others to rely on them. Nations with weak institutions, authoritarian governments, or histories of financial crises lack the trust necessary to establish a credible alternative to the dollar.
Ultimately, the attempts to challenge dollar hegemony have been fragmented, inconsistent, and unsuccessful. While the desire to break free from US financial influence is understandable, trust in a currency is not something that can be declared -it must be earned through decades of economic stability, institutional reliability, and global confidence. And for now, no other currency has managed to match the level of trust that the US dollar continues to command worldwide.
