How The Dollar Came To Dominate The World
Long before the establishment of the US dollar as a nationwide currency, a fractured nation was debating on how to establish itself financially.
Alexander Hamilton served as the first secretary of the treasury of the United States and committed himself to a deep study of the history of economies and currency. After much study, Hamilton found that establishing a national bank and currency was critical to creating a strong national economy.
At the time, this was a controversial idea as the Constitution did not give Congress incorporation powers. But Washington struck a deal with Hamilton to lobby for this national bank. Hamilton agreed to promote the moving of the nation’s capital to a new location which would later be Washington, D.C., while Washington conceded to support the establishment of a national bank under the purview of the “necessary and proper” clause in Article 1, section 8 of the constitution.
Hamilton’s study of economic power led him to lay out a vision for a debt-based economy, and a national bank was incorporated. Eventually, that led to the establishment of the Federal Reserve in 1913 when Woodrow Wilson signed the Federal Reserve Act into law.
Not long after the establishment of the Federal Reserve, we saw the printing of money, with the bank printing $10 bills with Andrew Jackson’s face starting in 1914.
But, it wasn’t until the Bretton Woods agreement in 1944 that the US dollar was officially championed as the world reserve currency. This was because the US had supplied all the allies with weapons and supplies for World War II, and the allied nations didn’t have much gold left for their own currencies. So, the US dollar was exchangeable for gold, and every other country that met in Bretton, Massachusetts agreed to peg their currencies to the US dollar.
Why Did the Dollar Ditch the Gold Standard?
In short, to fight inflation and to protect the US’ gold stockpiles. On April 5, 1933, President Roosevelt demanded all Americans turn in gold bullion worth more than $100. This, according to Keynesian economic theory was one way to fight an economic downturn, as masses of Americans were hoarding gold. By May 10, the US Government had collected over $770 million in gold bullion and certificates. After this, the US maintained a $35 per ounce price floor for gold until August 15, 1971, when President Nixon announced that the US would no longer convert dollars to gold at a fixed rate.
So, with the US ditching the gold standard, would anything replace it to uphold the value of the currency, besides faith in the US?
The Era of the Petrodollar
After the ditching of the gold standard, the dollar began losing value worldwide. On top of that, the Yom Kippur war resulted in an oil embargo placed on the US for their support of Israel. With these two issues facing the country, then-US Secretary of the Treasury William Simon and US National Security Advisor Henry Kissinger saw a way out.
In 1974, Simon made a deal with the then-Saudi King Faisal that has been one of the most defining economic deals of the last half-century. In that deal, Saudi Arabia agreed to only take payment for oil in US dollars in exchange for weapons and protection from the US. This created a huge need for US dollars in trading for oil. In addition, now all of the oil-producing countries needed something to do with their surplus of dollars, and the US provided a great landing place: US debt securities. This process was coined “petrodollar recycling,” referring to the cycle of US dollars being traded for oil and recycled back into the US economy.
The petrodollar agreement was widely unknown until about 2016, but there are some rumors that the agreement might be coming to an end. Saudi Arabia has entertained the idea of accepting payment in Yuan for Chinese oil, which would threaten the overall strength of the dollar.
Lessons From the Dollar’s Rise
In reflecting upon the dollar’s meteoric rise to power, a few general conclusions can be made. First, the dollar is still the world’s reserve currency. This gives the US a “home-field advantage” over other countries competing for this status. Second, the US has a playbook to use in defending its turf as the reserve currency. Given the fact that the US has held this status since 1944, the world is conditioned to view dollars as being valuable, something that would take quite some time to undo. Third, the US needs to maintain some backing behind its currency to preserve faith when institutions are being questioned.
The question of how we can save the dollar will be addressed in my next article, but I think it is important to reflect upon our past to best address our future options. The dollar is still the most powerful currency, but it must be handled responsibly to preserve its status. As John Adams wrote, “Remember, democracy never lasts long. It soon wastes, exhausts, and murders itself. There never was a democracy yet that did not commit suicide.” We must guard our republic and our currency with this attitude, or we might quickly find ourselves in the museum of fallen empires.