Money has had an intentional, bloody and tumultuous relationship with mankind throughout history. The word to "pay" is derived from the Latin "pacare" meaning originally to pacify or appease - through the appropriate unit of value customarily acceptable to both sides. Everything from salt to wampum have been used to appease both sides in a transaction. Indeed, in the Roman days it was a high honor for one to be worth their weight in salt. In the early days of the New World, colonists often bartered in wampum or tobacco due to the scarcity of British money at the time.
But even long before then, coinage was becoming limited to certain metals only with the most cherished one being gold. As the conquistadores roamed through the New World, they particularly focused on one and only one prize, gold. To find the fabled mine of gold would be the highest reward any soldier of the time could imagine. But to be the world bearer of trade, to be on top of most transactions taking place between a multitude of different nations and diverse transactions, a country needed to be considered the world power as well.
Thus, the Portuguese Escudo dominated world trade from around 1450 to 1530. The Spanish Peseta dominated world trade from around 1530 to 1640. After that, the Dutch Guilder ruled from around 1640 to 1720. Under Napoleon, the French Franc took center stage from around 1720 to 1810. The British Pound took over then and lasted as the main trading currency until the 1920s. Since then, the US Dollar has been the go to currency of choice for 70% or more of all world transactions. Clearly during these time periods other monies had a greater or lesser effect on world trading, but these currencies tended to dominate during their reigning years. The duration of their reign will be discussed towards the end of this talk.
There are good reasons why there is seldom more than one dominant currency. Reserve currencies have the attributes of a natural monopoly, or, in more modern parlance, a network. If it costs extra to trade with someone who uses a different currency than you, it makes sense for you to use the currency that most other people use. This makes that currency yet bigger and cheaper to use. There is a good analogy with a computer operating system. In that world, Windows is the dollar.
This networking power is why central banks store dollars in their reserves in a far greater proportion than the proportion of trade with the United States. While 30% of international trade is with the United States, 70% of central bank reserves are in dollars. It is why most commodities, like oil, copper, and coffee, are priced in dollars, wherever they are found and to whomever they are sold.
A closer look at the history of Great Britain's demise as the world's reserve currency in the beginning decades of the 20th Century reveals a country that was severely crippled after WWI. While Great Britain had tried its best to not get involved in the wars raging out of control on the European continent, it was nevertheless, thrust right into the First World War. This proved to be too costly for the British Empire. Although the Pound Sterling was still considered the main world currency, Britain, along with France and other allies of the war, owed millions of dollars to the United States. Great Britain found itself horribly in debt and unable to continue on the gold standard.
According to the Federal Reserve Bulletin of June, 1989, from the spring of 1925, when the gold standard was restored, to the fall of 1931, when it was abandoned, the Bank of England resisted forays on the exchange value of the pound sterling. In May 1931, a run on the Kreditanstalt, the largest Austrian bank, initiated the final defense of the gold exchange standard in Britain. From March to September 1931, the National Bank of Austria lost 55 percent of its large foreign exchange reserves as it tried to fight back capital flight. In June 1931, panic spread from Austria to Germany, and German banks scrambled to exchange sterling deposits for gold in London. From May 30 to June 30, the Reichsbank lost 34 percent of its gold and foreign exchange reserves. In July, with foreigners storming its gold reserve, the Bank of England shielded the domestic credit system by purchasing securities on the open market, by arranging a 50 million pounds credit with the Federal Reserve Bank of New York and the Bank of France, and by transferring securities from the Banking to the Issue Department to provide for new fiduciary issue. With the exchange rate below the gold export point, the Bank of England barricaded its gold reserves by raising the Bank rate from 2.5 percent to 3.5 percent on July 23 and to 4.5 percent on July 30. In spite of these protective efforts, gold reserves in the Issue Department shrank 30.9 million pounds--29 percent--from June 24 to July 29. Late in August, the Bank of England secured an additional 80 million pounds in emergency credits, but the continental and American demand for gold continued to assault the London bullion market.
In the last two months of its defense of the gold standard, Britain exported 200 million pounds in gold and foreign exchange. On Wednesday, September 16, withdrawals from Britain totaled 5 million pounds on Thursday, 10 million pounds; on Friday, 18 million pounds; on Saturday, a half day, more than 10 million pounds.
On Monday, September 21, 1931, the Bank of England went off the gold standard despite a total of 50 million pounds in credit from the Federal Reserve Bank of New York and the Bank of France. The pound sterling fell from $4.86 to $3.49 as a result of the devaluation. By December, 1931, the pound sterling was only worth $3.37. Since many nations tied their national currencies to the British pound, the subsequent devaluation (especially in comparison to nations who remained on the gold standard) resulted in an export subsidy and temporarily stimulated trade. However, the overall result was that most countries eventually abandoned the gold standard, currencies devalued, and overall trade contracted exacerbating the global depression. The move away from the British Pound Sterling to the US Dollar was one of the principle causes of the Great Depression of the 1930s which affected the entire world. The Bank of England almost went under. The headlines from the London Times of that day read, "Gold Standard Suspension: Cause of the World Crisis."
ENTER THE US DOLLAR
With the demise of the British pound sterling on the world's open market, the path was clear for the US dollar to take center stage. At the time the US dollar was the one remaining major currency left using the gold as a standard to back its currency. But even that fact was short lived. By 1934 the US dollar had left the gold standard as well. The currencies published thereafter stated, "This Note Is Legal Tender For All Debts Public And Private And Is Redeemable In Lawful Money At The United States Treasury Or At Any Federal Reserve Bank". It no longer stated, "X Dollars In Gold Coin, Payable To The Bearer On Demand".
But as the world plunged into the Great Depression, there was no other currency that was as buoyant as the US dollar. By the end of the decade another crisis of more immediate import darkened the clouds of Europe and extended its tentacles to much of the rest of the world. As one country after another descended into the bowels of war, first in Europe, then in those colonies still held by European powers, the economic structure of those countries collapsed in piles of bombed out factories and multi-cratered infrastructures. By 1945, the US stood alone as the only viable economy large enough to furnish these ravaged centers with the building materials needed to return to normalcy
THE BRETTON WOODS SYSTEM
Wikipedia states that, "730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire for the United Nations Monetary and Financial Conference. The delegates deliberated upon and signed the Bretton Woods Agreements during the first three weeks of July 1944.
"Setting up a system of rules, institutions, and procedures to regulate the international monetary system, the planners at Bretton Woods established the International Bank for Reconstruction and Development (IBRD) (now one of five institutions in the World Bank Group) and the International Monetary Fund (IMF). These organizations became operational in 1946 after a sufficient number of countries had ratified the agreement.
"The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value-plus or minus one percent-in terms of gold; and the ability of the IMF to bridge temporary imbalances of payments."