Why The World Cares About A US Financial Crisis

Many people understand that the American economy is in bad shape, but they’re not sure why they should care if they, themselves, aren’t American.

Well, the fact is, that you NEED to care because the American dollar is considered to be the standard unit of currency in commodity (mainly gold and oil) markets around the world and is the world’s prime reserve currency.

A reserve currency, also known as an “anchor” currency, is one which is held in significant quantities by governments and institutions as part of their foreign exchange reserves and, as such, determines a country or institutions ability to deal in global commerce.

If a country holds a large amount of the anchor currency in reserve, it can use that reserve to participate in global trade because it is assumed that regardless of what happens to the country’s own currency, the anchor currency owned by the government will support the trade activities.

As of 2009, the US dollar made up 62.2% of foreign exchange reserves, making it the single biggest backing currency in the world. The only other currency to come close was the Euro, which makes up 27.3% of foreign exchange reserves.

In addition to holdings in central banks and other institutions, there are many private holdings of US dollars outside of the US. In fact, it’s estimated that 2/3 of all US banknotes (most commonly in $100 bills) are held outside of the US.

Many economists have stated that it is this foreign demand for American dollars that allows the US to maintain PERSISTENT trade deficits (the US imports more than it exports) without causing the currency to devalue or the balance of trade to shift.

However, nothing lasts forever, and some economists, most notably Dr. Paul A. Samuelson, Nobel Prize Laureate in Economics, and Professor of Economics at the Massachusetts Institute of Technology, predict that the dollar will not hold up under this negative pressure indefinitely, and at some point there will be a “run” against the US dollar which will result in serious global consequences.

A run on a currency (or other commodity) occurs when confidence in it’s value declines and holders scramble to sell their holdings before they loose too much.

So, what has made the US dollar the world’s prime reserve currency?

During the first three weeks of 1944, in an effort to rebuild the international economic system from the ravages of the still ongoing Second World War, 730 delegates from all 44 allied nations gathered in Bretton Woods, New Hampshire, to deliberate upon and sign what became known as the Bretton Woods agreement.

This agreement established the rules, institutions, and procedures for regulating an international monetary system. The institutions established were the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), which is part of the World Bank Group.

The Bretton Woods agreement required each signing country to adopt a monetary policy that maintained an exchange rate of it’s currency within a fixed value, plus or minus one percent, in relation to gold.

Now, during World War II, most European countries found their ability to produce essential goods and services severely hampered as they sent farmers and workers to war as soldiers.

The United States, prior to it’s entry into the war, came to the aid of Europe by supplying the goods that were no longer being produced locally. Payment for these goods was negotiated in gold.

Due to these payments, by the time the Bretton Woods agreement was established, the US had become one of the major holders of gold in the world and the US dollar, being backed by huge reserves of gold, became the prime currency in the relationship. In other words, while the Bretton Woods agreement stipulated that all currencies have a fixed relationship to gold, the amount of gold amassed in the US effectively made the US DOLLAR an equivalent to gold, in terms of the agreement, and established the dollar as the reference currency for all member nations.

This situation may not seem to be of great concern, given that enough gold exists to back the US dollar, however, in 1971, US President Nixon unilaterally terminated the ability to convert the dollar to gold. In other words, he took the dollar off the gold standard, and effectively destroyed the Bretton Woods accord.

As a result, all the currencies that were backed by gold, according to the Bretton Woods agreement, including the US dollar, soon (if not immediately) left the gold standard and now “float” as “fiat” currencies.

Although the Bretton Woods agreement is no more, the US dollar still maintains it’s position of power due to the shear mass of it’s economy when compared to the rest of the world.

It’s status as the prime anchor currency keeps other currencies locked to the dollar’s value, whether the governments of those currencies like it or not, however, as stated earlier, nothing lasts forever, and many believe that the US dollar is rapidly approaching a time of decline, both in status and in value.

So, why does the world care about a US financial crisis?

Due to it’s direct and indirect effect on all the world’s currencies, a US problem becomes a global problem. It might not seem fair or just, but it’s a fact and one that ALL people need to be aware of.

To fully appreciate how the US problem can affect us all we need to become informed about how the world’s money system works.

I’ve put together some resources and articles from my research that help to explain these topics and, hopefully, give you a starting point.

I’d suggest you start with my article, “What’s a Fiat Currency?“, and follow the links within it to get a picture of what “money” really is, why I believe that the world’s money systems are in crisis, and how a potential world monetary collapse will affect us all.

I’d also encourage you to look at the videos on my Wealth Intelligence Community resource page. These are some of the most eye-opening pieces of information that I’ve come across since I began researching this topic.