US DOLLAR AS CURRENCY OF LAST RESORT

Over the past two years we have been witness to extraordinary events around the world, especially with regard to global economics. We have observe the fall of some of the most revered and trusted financial institutions around the world as well as the consolidation of others. Major banks have completely collapsed and incompetency has been exposed throughout the investment community.

Now, there is talk of rearranging the entire structure of global trading practices with the specific intent of lessening the hardship caused by volatility in the US economy and its own practices. It seems the world has had enough of the US dollar as the official world currency and wants to end the special status that such a title conveys.

But how did we get here? How is it that of all the monies in the world, only the US dollar holds the title of world currency?

To understand that, we must first travel back to before the time the US dollar was number one. We must go back before the concept of one global currency even existed. We must travel back to the end of the 19^th Century and the beginning of the 20^th Century.

Leading into the 20^th Century the general practice was to use gold as the main trading instrument between nations. It was thought that by keeping the value of gold consistent among all nations, the balance of trade between them would always remain level and consistent. The idea behind this is quite simple. If a nation exports more than it imports, its trade balance will be positive, the amount of gold would increase, and its currency would become stronger. Similar goods from other countries would become cheaper as a result and would take its place in the world market. It would start importing more than exporting, thus bringing it back in line with the rest of the world.

The major problem with this was that the amount of trade was directly related to, and restricted by, the amount of gold in the world. With gold at a fixed price and a fixed quantity, only so much trade could result. Increases could only occur when more gold was mined and put into circulation.

The 20^th Century saw a complete breakdown of gold as the world trading currency and by the end of WWII, it was necessary to find an alternative which would create better stability as trade increased over time. The Bretton Woods Conference in 1944 was supposed to resolve this issue. At the end of the Second World War, the US was almost completely unscathed. Europe lay in ruins and there was no other country with the economy to effectively manage worldwide trade, so it was decided that the US dollar would be the international instrument of choice going forward. The dollar would be the only currency pegged to gold and all other currencies would be pegged to it.

Unfortunately, countries still had the right to demand gold in lieu of dollars and France did just that in the late 1960s. By August, 1971, President Nixon could no longer abide by the rules of Bretton Woods and ended the accord when he took the US dollar off of the gold standard. He did, however, promise to maintain a “debt ceiling” that would keep the US from flooding the world with dollars unreasonably.

In March of that same year, Nixon announced a “permanent” US dollar debt ceiling in anticipation of his Bretton Woods decision. He promised the world that the US would never go over $400 billion in debt, thereby ensuring a de facto control on US dollar generation even without the use of the gold standard. Over the next eleven years every increase in that debt ceiling was considered “temporary,” until Congress finally completely removed the façade altogether in 1982.

According to the Wall Street Journal, we now have a debt ceiling of $12.1 trillion which will be reached by October, 2009. The Obama administration is looking to raise it over $1.5 trillion more in order to last until the next elections in 2010. It is also interesting to note that it was under $6 trillion when Bush took office, but nearly doubled during his time in office.

The increase in US debt ceiling, thus forcing an increase in dollar printing, has also meant an increase in dollars elsewhere. The world is flush with US dollars. China has around $2 trillion, Japan has over $1 trillion and other countries own trillions more. For some countries, the amount of US dollars in their financial portfolio make up the greatest percentage they have.

But American commerce is also big. From computers to fast food, US industry is still a giant in many areas of the world. Intel still owns the chip world, American software manufacturers are still on top, and other industries still command their fields. When the first McDonalds opened in Kuwait, the line of customers stretched for over six miles. 70% of Coca-Cola's 2002 revenue of $19.2 billion came from overseas operations where they have over 60,000 workers in Africa alone.

While pundits have been calling for hyperinflation and a total deterioration of the US dollar since 2006, there has been little evidence of this occurring anywhere. The exchange rates have remained in check during the entire time and trade between the US and other countries has gone on virtually unmoved. With all the talk about bubbles bursting, hallowed institutions going bankrupt, and economies going belly up, the world seems to be trucking along like a Ford Explorer over a country road. There are a few bumps and dips along the way, but that's only to ensure that the driver doesn't fall asleep.

So what's the problem?

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