LONDON, July 14 — There is a quiet, almost invisible machine at the heart of global finance, and for nearly eighty years it has run on the US dollar. The mechanism is straightforward: central banks and major financial institutions around the world hold vast quantities of dollars, not to spend on American goods, but as a trusted medium for international trade, a vehicle for investment, and a reliable store of value. This is the reserve currency system, and the dollar sits at its centre.
How it works is rooted in a specific historical settlement. After World War II, the Bretton Woods Agreement of 1944 formalised the dollar’s role by pegging other major currencies to the US dollar, and the dollar itself to gold at $35 per ounce.
That system collapsed in 1971 when President Richard Nixon ended the dollar’s convertibility to gold. Intriguingly, the dollar did not fall. Instead, it retained its dominance, sustained by the size and stability of the US economy, the depth of its financial markets, and its geopolitical influence.
The numbers, where available, illustrate the scale of this dominance. According to the International Monetary Fund, as of 2023 the US dollar accounts for approximately 59% of allocated foreign exchange reserves held by central banks worldwide.
The euro is the second-largest reserve currency at about 20%, followed by the Japanese yen, the British pound, and the Chinese renminbi. The Bank for International Settlements, in its 2022 triennial survey, found that the dollar is used in roughly 88% of all foreign exchange transactions. A handful of key institutions underwrite this system: the Federal Reserve System, founded in 1913; the US Treasury; and the IMF itself.
Their combined credibility and the network effects of dollar usage create a self-reinforcing cycle. The more the world uses dollars, the more liquid and safe the dollar system becomes, and the more it is used. Challenges have emerged, but none have yet matched the dollar’s liquidity, safety, and network effects.
China has made concerted efforts to internationalise the renminbi. The creation of the euro in 1999 provided a potential rival.
There have also been proposals for a new global reserve currency, independent of any single nation. Yet no alternative has yet matched the dollar’s combination of liquidity, safety, and network effects. What researchers and economists call the ‘exorbitant privilege’ flows directly from this status.
The United States benefits from lower borrowing costs and the ability to run persistent trade deficits, a flexibility no other country enjoys. The mechanism is simple: because the world wants dollars, the US can borrow cheaply and spend beyond its means without triggering the usual consequences.
For now, the dollar’s position appears secure. The key question, as central banks in Beijing, Brussels, and elsewhere continue to explore alternatives, is whether any challenger can build the depth of financial markets and the institutional trust that took the United States decades to assemble. The science behind reserve currency status suggests that such shifts, when they happen, are slow.
But the history of Bretton Woods also shows that systems can break.
