Published: 20 September 2013

The US dollar as the world reserve currency simply means that most of the world's transactions across borders that are related to the trade of real goods (oil, food, cars, computers, etc.) and capital flows (major financial deals and movement of large pools of funds) are denominated in US dollars.

The reason it came about is because the US became the dominant world economic and political power after the demise of Great Britain and has maintained that role in the world ever since.

This role is very important for the US government because the reserve status affords more political and economic power to the US accordingly. Unfortunately, it allows the US to spend more freely than other nations. Why? Remember, other nations have to hold dollars in order to transact international trade. They don't have to hold British pound or euro or Japanese yen, per se.

So as you can see, the reserve status is quite important for the US sphere of influence and for the dollar. If countries didn't have to hold dollars to trade, the dollar would likely be even lower based on the sharp rise in US debt and decline in overall economic position relative to rising competitors such as China and others.

The problem is: the very nature of a world reserve currency is a flawed concept. This was first discussed by an economist name Robert Triffin. And his suppositions became known as Triffin's Dilemma.

Seemingly apparent to most people lately is the critical role the US dollar plays in global growth, precisely because it is the world reserve currency. Remember that during the credit crunch the dollar soared in value; this represents the proverbial "risk bid." The reason for this was that dollar-denominated credit escaped from the world economy very fast. Thinking in these broader terms of how the dollar provides growth for the rest of the world is where Triffin's Dilemma comes into play.

In 1960, Mr. Triffin wrote a book titled Gold and the Dollar Crisis: The Future of Convertibility. In this book, Mr. Triffin identified the problems for the US economy if the dollar became the principle reserve currency in place of gold. He really nailed it.

Role of the Dollar as Global Reserve Currency

- Black Swan Capital

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