How the U.S. Dollar Became the World's Reserve Currency

A world currency is any money that can freely be used or exchanged for another currency inside or outside the borders of the country that issues it. It may also be called a global currency. The first U.S. dollar (USD) is the official currency of the United States and several other countries.

The dollar was first printed in 1914, a year after the establishment of the Federal Reserve as the U.S. central bank with the passing of the Federal Reserve Act. Three decades later, the dollar officially became the world’s reserve currency.

History of the U.S. Dollar

The first documented use of paper currency in the U.S. dates back to 1690, when colonial notes were issued by the Massachusetts Bay Colony. These notes were used to fund military operations. It wasn't until 1776 that the first $2 bill was introduced. Nine years later, in 1785, the U.S. officially adopted the dollar sign, using the symbol for the Spanish-American peso as a guide.

The government established the Office of the Comptroller of the Currency (OCC) and the National Currency Bureau in 1863. These two agencies handled new banknotes. Centralized printing began at the Bureau of Engraving and Printing in 1869. Before this, money was printed by private companies.The U.S. Treasury began issuing the nation's legal tender in 1890, more than a decade before the creation of the Federal Reserve.

The Gold Standard

The Federal Reserve Act of 1913 created the Federal Reserve Bank to respond to the unreliability and instability of a currency system that was previously based on banknotes issued by individual banks. The U.S. economy surpassed that of the United Kingdom, though world commerce still centered around the U.K., with transactions taking place in British pounds.

The majority of developed countries pegged their currencies to gold as a way to stabilize currency exchanges. When World War I broke out in 1914, many countries suspended the gold standard to pay their military expenses with paper money, which devalued their currencies. Britain held to the gold standard to maintain its position as the world’s leading currency and found itself borrowing money for the first time during the third year of the war.

The United States became the lender of choice for many countries that wanted to buy dollar-denominated U.S. bonds. Britain abandoned the gold standard in 1931, which decimated the bank accounts of international merchants who traded in pounds. The dollar replaced the pound as the leading reserve currency.

The Bretton Woods Agreement

Before it entered World War II, the United States served as the Allies’ supplier of weapons and other goods. Most countries paid in gold, making the U.S. the owner of a majority of gold by the end of the war. A return to the gold standard became impossible as countries depleted their reserves.

Delegates from 44 Allied countries met in Bretton Wood, New Hampshire, in 1944 to develop a system to manage foreign exchange that would not disadvantage any country. The delegation decided that the world’s currencies would no longer be linked to gold but pegged to the U.S. dollar.

Known as the Bretton Woods Agreement, it established the authority of central banks, which would maintain fixed exchange rates between currencies and the dollar. In turn, the United States would redeem U.S. dollars for gold on demand. Countries had some degree of control over currencies in situations where the values of their currencies became too weak or too strong relative to the dollar. They could buy or sell their currency to regulate the money supply.

The World’s Reserve Currency

The U.S. dollar was officially crowned the world’s reserve currency and backed by the world’s largest gold reserves thanks to the Bretton Woods Agreement. Instead of gold reserves, other countries accumulated reserves of U.S. dollars. Needing a place to store their dollars, countries began buying U.S. Treasury securities, which they considered to be a safe store of money.

The demand for Treasury securities and the deficit spending to finance the Vietnam War and the Great Society domestic programs caused the United States to flood the market with paper money. With growing concerns over stability, the countries converted dollar reserves into gold.The demand for gold was such that President Richard Nixon was forced to intervene and de-link the dollar from gold, which led to floating exchange rates.

As of 2022, central banks held around 59% of their reserves in U.S. dollars, according to the International Monetary Fund (IMF). Many of the reserves are in cash or U.S. bonds, such as U.S. Treasuries.

The Bottom Line

The reserve status is based on the size and strength of the U.S. economy and the dominance of the U.S. financial markets. U.S. currency and U.S. Treasury securities are a common way to store money. In 2022, global central banks held over half of their reserves in U.S. dollars.