The first printing of the US dollar as we know it today took place after the establishment of the Federal Reserve in the year 1914 (Prior to this, the bank notes were issued by individual banks).
In the present times, the US dollar is one of the strongest currencies in the world (The strongest currency is “The Kuwaiti Dinar”).
The US dollar is the official currency of not only the United States but also various countries of the modern world.
In this article, we would try to trace the history of the US dollar from the year 1914. i.e. when the US dollar was “first” printed.
1914 was also a historic year for the world. The reason was the break out of the first world war.
Situation prior to 1914
Gold standard
The system in which the currency of a country was directly linked with gold.
The value of a currency in the gold standard was determined on the basis of the value of the gold.
In the present world, the gold standard is not followed by any country. The gold standard is now replaced by the “Fiat Money System”.
Fiat Money System
The system in which the currency of a country is backed by the government guarantee rather than gold. Due to the backing of the government, the currency is used as a means of payment.
Prior to the first world war, all the international trades were settled through gold and pound.
The gold started to accumulate in the hands of those countries which were net exporters (.i.e. exports were greater than imports). This led to the reduction of gold reserves in the hands of those countries that were net importers.
The situation before World War-I
Before the first world war, the British pound was the reserve currency of the world. i.e. the central banks of the countries had the British Pound as their reserves (as it is the dollar in today’s world).
In international transactions the British pound had dominance and it could be used for the settlement of the international transaction.
Pre-war impacts of the Gold Standard on the US
Before World War-I, following the “Gold Standard” had international as well as national impacts on the United States.
Internationally; the dollar was pegged at the “Fixed Rate” with the gold which was 20.67 $ = 1 ounce of gold.
Domestically; the US was restricted from expanding the supply of dollars into the economy (the reason was the fact that a country could only print currency on the basis of the amount of gold it held).
If the country wanted to print more currency, it could only be done by increasing the gold reserves.
During World War-I (1914-1918)
The situation with the US in the first year of the war
The pre-war exchange rate parity between the Pound and the US dollar was 1 Pound=4.8 $.
After the breakout of the war in Europe, the commodity and financial markets in the US were disrupted heavily.
The reason was the dependence of US markets (both commodity and financial markets) on Britain and Britain had already entered the war.
The debt payable by the US to Europe increased heavily. Due to the debt burden on the US, the investors holding US securities started to dump their investments in US security.
The Reason was the investors feared that the US might not be able to repay the debt in the pound.
Due to the instability in the US, the investors started to dump dollars and converted the dollar into gold to buy the British Pound.
As the dumping of the US dollar started, the demand for the pound increased (because the Pound was a more stable currency than the dollar at that time) which led to the shooting of exchange rate parity between pound and dollar to 1 pound = 6.75 $ which was previously 1 pound = 4.8 $ before the outbreak of war.
The gold started to flow out of the US to Britain due to the reason that British Pound was at a premium in comparison to the US dollar. Therefore, the export of gold was highly profitable.
Understand this by an example:
Suppose you exported anything to the US when the exchange rate was 1$=60Rs, you would get 60Rs for each dollar billed to the US. Now if the exchange rate becomes 1$=80Rs (.i.e. dollar is appreciating or we can say the rupee is depreciating), you would get 80Rs for the same 1$ billing to the US. The exports are always profitable from the country whose currency is depreciating. (Read more here)
The entire financial system in the US was on the verge of collapse.
As a measure to prevent the fall of the dollar and repay the European debt, the US temporarily suspended the gold standards, printed additional currency notes, and prohibited the export of gold.
The situation with the US in the later years of the war
The First World War was fought between the years 1914 to 1918.
The US entered the world war in the year 1917.
As the war was fought for four years the European countries concentrated more on war efforts rather than production and internal economic developments. Due to this, inflation surged and the demand for commodities to feed the people arose.
The US emerged as the supplier of commodities to the belligerent countries in the world (countries who participated in war).
As we said earlier, international transactions could be settled in gold and pound. The US emerged as the supplier of weapons and commodities to the belligerents and therefore the gold reserves started to pile up with the US because the US decided to receive payments for the supplies in gold rather than the pound.
This was the time when two parallel powers started to emerge in the world. The Britain and US.
In the times of gold standards, the currencies of major countries of the world were pegged against gold. The British pound was also pegged against the gold as Britain was also the country that accepted the gold standards.
World War I continued for a long period of time. The belligerent countries required finance for weapons and other supplies. The world entered into the vicious cycle of lending. The US emerged as the “lender of the world” including Great Britain.
The US emerged as the supplier of the world during times of war and wanted the payments in gold.
Britain had two frontiers to face; one is to maintain the stability of the pound (as it needed more gold to make payments to the US. More demand for gold led to the fall of the British Pound) and second, the gold was in limited supply and therefore it could only be used in a limited manner (.i.e. it cannot be used indefinitely)
So it was decided to peg the pound with the US dollar at the rate of 1 Pound = 4.7 US dollars.
Temporary suspension of gold standards
The European countries including Great Britain and the US suspended the gold standards.
The reason was; the countries needed money for financing the war expenditure. This could only be done by printing more money but the supply of gold was limited. So it was not possible to print money without holding more reserves of gold.
Post-war scenario
After the end of World War-I, the money supply in the US increased, and the wholesale price inflation doubled.
As a measure to curb inflation, the US Fed raised the interest rates to 6%.
The money became “Dearer” .i.e. when it becomes hard to borrow funds due to increased rates of interest the money is called the “Dear Money”.
Due to the “Dear money”; the output fell, the demand fell and therefore the Inflation fell.
The US entered a phase of recession between 1920 to 1921.
The great depression (1929 to 1941)
Several measures were taken to restore the gold standards which were suspended during the period of World War-I.
After 1920 when the US economy was trying to recover from the mild recession; the US Fed supported the economy by reducing the interest rates.
This led to cheaper loans and therefore increased the supply of money which in turn led to the rapid expansion of the economy. This period was called “the roaring twenties”.
Cheap money brought expansion in every segment of the economy be it automobile, manufacturing, production of iron and steel, and technological advancements throughout the US.
In short, there was rapid industrial growth in the US. The share prices started to boom as there was a rapid expansion in the US.
People were attracted to the Stock Markets even if they knew nothing about the stock markets. They just wanted to buy cheap and sell high.
Even the loans were taken to invest in stocks, brokers provided margin to the clients (.i.e. the clients were allowed to buy shares even if they had no money for buying)
People even mortgaged their homes for investing in stocks.
After a period of time, it was realised that the production was surpassing the demand. Soon after the realisation, companies started to offload the stock of goods, which they had, even at losses.
This led to bad financial results for the companies which further led to the drawdown of the share price of companies to the extent that US markets crashed almost to 90%.
Due to the fall in the share price of the companies in stock markets, the investors were forced to sell their holdings at loss due to which the loans taken for the investment in shares became non-performing assets for banks.
The banks failed due to the non-repayment of loans by the borrowers. The brokers failed because the margin money was not paid to them.
Due to the lack of demand, the agriculture sector was also affected badly. Due to the lack of demand and dirt-cheap prices of agricultural produce, the farmers became bankrupt.
The situation during World War II (1939 to 1945)
As we saw, the US entered World War-I approximately three years after the war has begun. The US did the same in World War II. The Second World War started in 1939 but the US entered the war in the year 1941.
Before entering the war, the US emerged as a supplier of commodities and weapons to the belligerent nation (the same happened in World War-I).
Same as in World War-I, The US demanded payment in gold. This made the US holder of the largest gold reserves in the world due to the concentration of the world’s gold reserves in the hands of the United States and the deficiency of gold with other countries.
It was almost impossible for the world to return back to gold standards.
Bretton woods agreement-1944
In the year 1944, the delegates of various countries (44 countries) met at a place called Bretton Woods in New Hampshire for the purpose of developing an exchange rate system in the world that could be beneficial to all countries.
Due to the holding of the majority of gold reserves in the US, it was decided to peg the US dollar with gold and the currencies of other countries would be packed against the US dollar.
The rate at which the US dollar was pegged to gold was $35 for 1 ounce of gold. i.e. for printing 35 dollars 1 ounce of gold must be there in the US reserves.
As the currencies of other countries were pegged against the dollar, the countries started to accumulate the US dollar in their reserves.
Now the US dollar got the crown of the reserve currency of the world. The countries that had accumulated US dollars started to park their dollars into the US treasury securities. This led to the increased demand for US treasury securities.
Vietnam War (1955 – 1975)
This was another war that again bought a shift in the world economic regime. The US also participated in this war.
Every war requires funds for expenditure. So did the Vietnam War required. Here again, the US was the prime Spender as in World War-I and World War II.
Due to the funding of the Vietnam War (internationally) and various domestic programs (internally in the US), excess dollars were printed and therefore the US economy was flooded with money.
This stance was contrary to the Bretton Woods agreement wherein it was agreed that the US dollar would be pegged against gold.
This means the US should maintain the supply of dollars only to the extent of gold reserves it had, but for financing the Vietnam War and domestic programs the US did not honor the agreement.
The excess printing of the US dollar created questions about the stability of the dollar. The reason was the fact that the supply of the US dollar exceeded the gold reserves held with the US.
As we know every country wants to put its funds in safe and stable currencies. But now the question started to rise on the stability of the US dollar.
The countries started to dump the dollar and converted their dollar reserves again into gold.
Impact of the then US president during the time of Vietnam War
During the time of the Vietnam War, Richard Nixon was the President of the United States in 1969.
The dumping of the US dollar by the countries led to the fall and instability of the dollar. To protect the dollar and bring out stability to the regime, Richard Nixon decided to put an end to the pegging of the US dollar with gold.
As of today, the same system is followed in the world. None of the currencies are pegged to gold. The US dollar became the reserve currency of the world as of now.
All the central banks of the world are free to manage the money supply by increasing or decreasing the interest rates as per the needs of their economies.
This system gave enormous powers to central banks. We know that power has to be used with intelligence and pro-activeness; which means the central banks had to now become more responsible for their decisions when it comes to managing the money supply.
What factors made US dollars, the reserve currency
The most important factor which makes the currency of a country acceptable as the reserve currency is the stability and size of the domestic economy.
Investors always want to park their funds in a country whose stability is not questionable as everybody wants the safety of their money.
Stability in the economy comes with macroeconomic policies. Macroeconomic policies include
Monetary policy (monetary policy framework is the job of central banks and they have to be strong and proactive to ensure adequate monetary supply in the country) and
Fiscal policy (fiscal policy framework is the job of central governments therefore the central governments have to be stable and competent enough to prepare concrete policies to attract foreign funds)
The country has to first raise its importance in international trade as we have seen in the world wars, the US emerged as a supplier of the world.
Open and developed financial markets so that the country becomes attractive for investors and the currency has to be freely convertible without any restrictions.
All these qualities were there in the economy of Great Britain which was subsequently acquired by the United States and therefore US dollar replaced the British pound as the reserve currency of the world.
Excellent write up…