The role of the dollar as a linchpin of the international monetary system is one of the most debated issues in the post-WWII global economy.

Agreements on world trade and finance, adopted at Bretton Woods in July 1944, quickly proved inadequate. The system of fixed (but adjustable) exchange rates, and the fixed price of gold, were breaking down already in the 1950s.

The agreed system was too rigid, and the recovering West European economies refused to follow a prompt and symmetric adjustment of their trade balances – a rule enshrined in the original Article IV of the International Monetary Fund.

So, instead of running balanced trade accounts by properly adjusting their monetary and fiscal policies, the Europeans were redeeming their dollar-denominated trade surpluses at the U.S. Federal Reserve at an unconditionally guaranteed price of $35 per ounce of fine gold.

That system put the dollar at the center of the world monetary system, where currency exchange rates were fixed, and occasionally changed, in terms of their dollar values.

The U.S. became the banker to the world by producing the money supply needed to drive the global economic output and employment.

A more flexible monetary system

The inherent instability of that system was obvious. Some French analysts were pointing out in the 1950s that America’s international liabilities exceeded the value of its gold reserves. France, consequently, began converting in the mid-1960s its dollar holdings into gold.

As expected, the growing pressure on U.S. gold reserves led to the suspension of dollar convertibility for private transactions in 1968, followed by a total closure of the U.S. gold window in August 1971.

That’s the year when the market price of gold shot up to $41, while the managed floating of exchange rates became the norm in the international monetary system.

Where are we now, and where do we go from here?

Put briefly, the price of gold at this writing was $2,420.70 and the dollar accounted for 59% of global currency reserves, down from 72% at the beginning of this century.

Both metrics are usually – and mistakenly -- understood as indications of an impending demise of the dollar as the world’s key currency.

To see that fallacy, one has to look at how well the dollar fulfills the functions of a truly global monetary unit.

Money plays three essential roles in an economy.

First, money provides a standard of value -- a unit of account to compare prices and determine the relative value of goods and services. A national currency does that within a particular economy, but only an instantly recognized – and globally accepted – currency like the dollar can provide such a measure of value in international business transactions.

U.S. should strengthen the world monetary system

Second, money also serves as means of payment – a medium of exchange. That’s an area where the dollar remains unmatched as a world’s transactions currency. The Bank of International Settlements (aka “the central bank of 63 central banks”) estimates that the dollar accounts for almost 90 per cent of foreign exchange transactions and for 85 per cent of transactions in spot, forward and swap markets.

Third, people hold on to money as a store of value. That particular function of the dollar is “measured” by the share of the dollar in global currency reserves and the dollar’s value in terms of gold.

Most dollar discussions focus on its store of value function and completely ignore the dollar’s fundamental importance as a standard of value (unit of account) and means of payment in international trade and financial transactions.

But that’s where the dollar’s position seems quite secure for the foreseeable future.

Dollar holdings also play a crucial role in the monetary management of small- and medium-sized economies because exchange rates influence price stability, trade flows, economic growth and employment creation.

Speculations about a supposedly weakening position of the dollar in world economy are now taking place in an increasingly hostile and adversarial environment created by Obama’s “Pivot to Asia” to contain China and an apparently intractable war in Europe.

One must observe, however, that those unfortunate events have already created a growing trade fragmentation along the new security fault lines -- but they have not created similar changes in global currency reserves.

At the end of last March, the dollar accounted for 59% of world currency reserves, followed by euro’s 20%, Japanese yen’s 5.7% and pound sterling’s 4.9%.

The West’s currencies, therefore, still constitute 90% of the world’s store of value. Surprisingly, the share of China’s renminbi has declined to 2.1% from 2.8% at the end of 2021.

The dollar has no alternative as the world’s key transactions currency. Its reserve role is secure and could be considerably strengthened by America’s price stability, sustained economic growth and constructive contributions to global peace and security.