Posted on: 17-08-2017 in Finance
As the reserve currency of the world, the history and behaviour of the US dollar is key to understanding many markets. So how did the dollar get going as a currency? Holborn Assets reviews the history of the US dollar and asks especially: what has the Greenback been doing in 2017?
US political dramas have both obscured and clarified the 2017 story of the US dollar:
The new Trump administration has had a dramatic Summer at home and abroad – with some saying that it’s not just the US dollar that has diminished against its peers, but the entire credibility of the prime mover on the international diplomatic stage.
Tensions with Russia have been a major issue: US intelligence agencies maintain that the Kremlin influenced last November’s presidential election. Donald Trump Junior, in particular, has been under scrutiny for his links to a Russian lawyer (supposedly a makeweight in unearthing
Clinton secrets), and “Adviser-On-Everything” Jared Kushner has been in the public eye too.
The White House boss continues to brush off all allegations – though for good measure Trump has made redundant one of the men leading the investigation against him, ex-FBI director James Coney. This has led to a Congress-inspired tit-for-tat with Russia in which Russia ejected 755 US staff from their Moscow embassy.
Russia aside, there is the face-off with hermit state North Korea, a nuclear-related tour de force that this week has led to China’s president, Xi Jinping, unexpectedly diffusing the tension between North Korea and the US.
On 3 August 2017, as the Washington-Moscow tensions simmered, the currency reached its six-month low of 0.8433 against the Euro (the chief currency pair). Despite a brief rise in fortunes and steadiness in the last week, that low has followed a protracted weakening since the start of the year. This is good news for American exports, of course, as well as tourists to the country – and has had many precedents in the history of the US dollar.
Indeed, the US dollar’s decline has coincided with a subsequent rally for the Euro, reminiscent of the greenback’s own rally in 2014.
Despite the long-held view that China’s global influence and fast growth relative to G7 peers would see its Renminbi supplant the dollar as the global currency, by mid-2017 there is still no more signs this will happen.
China’s increasing power is driven by its global investment, buying existing assets of developed and emerging nations alike and forging development partnerships in developed and emerging nations alike.
The purchase of commodities is at the heart of such investments and deals. Dambisa Moyo, in her book Winner Take All, chronicles the fast and substantial development of the People’s Republic’s overseas portfolio with resources, from a Chinese company’s $3 billion purchase of the mineral rights to a mountain in Peru to a $13 billion investment in Australian aluminium production.
The renminbi remains restricted in global markets; with the Chinese happy to convert into the other major currencies to make their investments. Until access to the currency increases, its influence (compare to its sheer financial and military power) will not change.
The history of the US dollar shows that it enjoys the opposite situation to the Chinese renminbi: the world’s biggest economy has the most accessible currency in the world. It is one of the major ‘floated’ currencies, meaning its value fluctuates within the $5.1 trillion foreign exchange market as per supply and demand. The US dollar can be exchanged for local currency in as many countries as you care to name!
It is the official currency of three overseas American territories, but also seven non-related countries. The US dollar is also the reserve currency in countries such as Lebanon, where monetary instability requires a back-stop, supplementary currency to the local cash to stave off rapid inflation or – in the opposite scenario – a stoppage in local banknotes. The Euro also performs this function in a number of African countries.
In other parts of the world, such as the Caribbean, the US dollar is central to the islands’ commerce, since so much of their tourist spending is in this currency.
The US dollar is also the ‘peg’ for 13 countries, meaning that the local currencies have a fixed exchange rate with the dollar, and so essentially rise and fall in value against other currencies at the same time and to the same proportions as the dollar. This helps increase the market
liquidity – the ease and price-efficiency of buying and selling – of these local currencies.
Many of these pegged currencies are in the Middle East, including the big oil-producing nations. Since oil is globally priced in dollars, this allows such countries to avoid any fluctuation between their own currency and essentially the commodity’s currency.
Indeed, the renminbi was pegged to the dollar until 2005; in an episode of leap-frogging, the newest global powerhouse (China) made use of the steady cash value of the powerhouse that came before (USA).
How did the US dollar become the most liquid, most accessible, most used and relied upon global currency? Let’s look at a fistful of … history! The history of the US dollar:
The emergence of the US dollar is linked inextricably with that of its issuing country: influential country, influential currency (save perhaps for China and its renminbi).
After the second world war, the US’s emergence as the dominant economic power also saw hundreds of countries peg their money to it. But the country saw explosive growth across its vast land mass for more than a century before the Second World War, and its currency’s influence subsequently expanded.
Many countries have been involved in the US dollar’s establishment as a currency. The word ‘dollar’ in English- speaking nations derives from ‘thaler’, which itself comes from the end of ‘Joachimsthaler’, the name of the coins first minted in 1519 from silver mined outside the Bohemian town of Joachimsthal, now part of the Czech Republic.
Today’s currency name was later applied to similar coins, including the Spanish peso and the Portuguese eight-real piece, which were very similar currencies in terms of weight. The latter’s money lends its name to the phrase of pirate fiction, ‘pieces of eight’.
The conquests of the Spanish and Portuguese empires in South America in the 16th century and their mining activities – in Peru, Mexico and Bolivia in particular – saw the term of “dollar” gain greater usage. It even shows up in literature: the dollar as a unit of currency is mentioned in two of William Shakespeare’s plays, Macbeth and The Tempest; two works written at the start of the following century.
These European empires’ successes in South America are also at the heart of the US’s adoption of theme for its nascent country, and its unit of price. Spanish fleets, defeating the Inca and Aztec empires, wasted little time surveying the land and mountains, digging for the metal, with a particularly rich area found in Potosi, now Bolivia.
Spain traversed the world, trading its produce and establishing its dollars as an international currency – easy to do when you dominate the silver supply! Spain traded all over Europe and as far as China. It also claimed territory in what is now the US, including the whole of the west coast from Mexico up through California.
When America was subsequently established as a collection of 13 east-coast colonies, Spanish dollars started to be used in certain areas as the backing for paper money.
The Massachusetts Bay Colony was the first to issue such money in February 1690, in order to fund its war and pay soldiers’ wages. The territory, however, had been minting its own coins since 1652 – just like Bohemia more than a century earlier – despite a British law against it.
The British government passed numerous Currency Acts in its London parliament during the 1770s to regulate colonial currency. The country’s pounds, shillings and pence were in circulation among the colonies, though values differed between colonies, as well as the Continental Currency. During the 1775 revolution, other states tried to copy Massachusetts but lacked the precious metal backing to maintain any value. Paper money instead suffered great inflation.
The 1776 American Revolution freed what became the United States of America from such external controls, and paper money flourished as bills of credit so that each state could fund its economy in trade. In particular, paper money was used as deferred payments to the soldiers that they could then use as (essentially) IOUs from the colony.
Ad hoc measures aside, the collapse of the Continental Currency and inflation among the neighbouring US states required a unifying and steady currency system.
By 1787, US states were forbidden to issue their own bills of credit, and in 1792, the Coinage Act was passed by Congress, pegging the dollar to the Spanish silver dollar and subsequently creating the United States Mint. This entity was charged with issuing coins and regulating the money flow. The Mint became part of the Department of the Treasury in 1873.
A standardised currency required precise controls. Alexander Hamilton, secretary of the Treasury, determined the standard amount of silver in a dollar, and so the currency itself was a unit of pure silver weighing 371 4/16th grains (24.057 grams). Smaller denominations of the dollar, therefore, were relative to this amount: a half dollar contained half the silver as a dollar; the quarter dollar a fourth of the amount.
Despite the common coinage, paper money still varied greatly among the states. TheMoneyProject found in their investigation of the history of the US dollar that up to 10,000 different types of paper money were used in the run-up to the American Civil War, making the funding of the war by the Federal government very difficult. As such, in 1861, the $10 bill was issued, swiftly followed by fractional bills, and a ‘fiat’ money began to emerge; not based on a gold or silver ratio but backed by the Federal government instead. The Confederate southern states, the opposition in the Civil War, soon also started issuing and using standardised bills.
By the start of the 19th century, the price of gold increased so much relative to the price of silver that the ratio between the two metals was. A gold standard became more prominent by the 1850s.
The two metals (gold and silver) were used as back-stop values during the American Civil War. But it was only after the 1863 National Banks Act established a monetary system in which banks could issue paper notes based on their holding of government bonds.
The silver standard thus preceded the gold standard. The US started on the de facto gold standard in the 1870s after the price of silver internationally fell when the German empire stopped minting coins after the Franco Prussian war. By the start of the 20th Century, the Gold
Standard Act removed silver entirely from the country’s monetary system.
The first decade of the 20th century saw a number of financial panics. To steady the country’s internal market, the Federal Reserve Act saw the establishment of the Federal Reserve System in 1913, essentially creating the country’s first true centralised bank through a network subsidiary bank over 12 districts across the country. The System had the objectives of boosting employment and stabilising both prices and long-term interest rates.
As explored above, the use of the US dollar as an international peg after World War 2 transformed its influence in the world and its contribution to global trade. Indeed, the US’ development and use of the dollar upon its independence has echoes in the 20th century, when numerous other countries gained independence from Great Britain and fell back on the dollar.
Countries gaining independence either used the US dollar or called their new currency dollar. Zimbabwe adopted the US dollar to replace the British pound upon its independence, later to develop its own currency.
Other times, newly independent countries used the term ‘dollar’ but the currency was very much the countries’ own. Singapore and Hong Kong are two examples of this.
At other times, the name would be used within British-held colonies – then upon independence, it would keep the name and then gradually replaced with a national currency. Malaysia originally used the Malaysian dollar to replace the Malaya and British Borneo dollar in 1967, before replacing it with the Ringgit. Australia, Canada and New Zealand, three countries still within Britain’s commonwealth of nations, still use the name.
Today, the digitisation of money has made the currency’s issuance and flow a completely different world to that of the early Federal Reserve, let alone anything before in the history of the US dollar. The size of US dollar print runs is simply astronomical. Last month, the Federal Reserve’s board of governors submitted its order for 2018 for around 7.4 billion Federal Reserve notes, valued at $233.4 billion, to the U.S. Treasury Department’s Bureau of Engraving and Printing.
Explore further with Holborn Assets how the US Dollar became the global reserve currency.