Many people are asking Why Is the U.S. Dollar the World’s Currency?

Before World War II, all global currencies were backed by gold and each government guaranteed that its money was good for a certain amount of gold. Then came the Bretton Woods agreement of 1944, which created the World Bank and the International Moneatary Fund, and also established the U.S. dollar as the new gold. (The U.S. held most of the world’s gold supply.)

According to Jonathan David Kirshner, a professor of political science and international studies at Boston College, the dollar continued to dominate during the post-WWII boom years. The rise of the “dollar order” was built on four pillars:

1. the robustness of the U.S. economy
2. the widespread belief in the American model of finance,
3. the wealth of U.S. financial institutions
4. America’s leading role in international affairs.

Most of the world’s monetary relations were orchestrated between the U.S. and its political allies and military dependencies and it was natural to be conducted in dollars.

The Bretton Woods fixed exchange rate scheme collapsed in the 1970s, when Richard Nixon took the dollar off the gold standard during a period of domestic inflation, and many industrialized economies chose to “float” their currencies on the open market. At that time, some economists began to predict the downfall of the dollar. Not that it would lose value, but that it would lose its dominance as the world’s de facto currency.

Over the decades, most of those “pillars” that made the dollar king of the postwar economy have been toppled, recessions, stock market bubbles and the global financial crisis have revealed cracks in the American financial model, and the U.S. has lost some of its political dominance, with many governments and corporations choosing to do business with China or Europe instead.

Yet the numbers show that the dollar is still the currency that nations and individuals turn to as a “safe harbor” in economic storms. But why? The ultimate reason is a simple one, “the lack of a plausible alternative. If not the dollar, then what?”

There have been periodic calls to shift more reserve holdings to the euro, the Chinese RMB or even back to gold, but the dollar still reigns supreme. When countries shop for a reserve currency that’s stable, secure and liquid (easy to convert back to local money), the dollar is still the default. In fact, some countries such as Panama and El Salvador use the U.S. dollar as their legal tender. The U.S. government doesn’t have to give approval for another country to use the dollar as its official currency.

Some people asked What About a One World Currency? Well the answer is “not gonna happen”.

The first reason is political. There is simply no political will to have one world government or one world currency.

The second reason we won’t see an “Earth dollar” (or the whole world using the U.S. dollar for their official currency) any time soon has to do with an economic theory called “optimal currency area” that states that a single currency only operates efficiently over a relatively small geographic area — the size of a country, for example, not a continent. That’s because different regions might be experiencing very different economic conditions at the same time. One country might be in recession, for example, while another is booming.

If you only have one money in the whole world, then you only have one monetary authority, which means you only have one monetary policy. In reality, different regions or countries would need monetary policies more tailored to their individual needs.

That’s one of the reasons why the euro hasn’t supplanted the dollar as the global currency. The eurozone itself is not an optimal currency area, which means that EU authorities have to enact monetary policies that somehow serve economies in very different financial conditions, like Germany and Greece. Events like the eurozone debt crisis further eroded faith in the euro as the next default currency.