Forex: The International Role of the Dollar

It is a fact that dollars have been after gold, the most important component of the world's international reserves; they amounted to 25.9 percent of the total in 1970.

Using the foreign currency reserve holdings of all the IMF members as a base of 100 percent, in 1970 the dollar represented almost 54 percent of the total, followed by sterling at about 14.9 percent and all other currencies at 31.9 percent.

In addition to its role as a reserve currency, the dollar has been an important vehicle or transactions currency. Many transactions, including some between non-dollar countries, are negotiated and liquidated in dollars.

When some residents of non-dollar countries preferred to purchase the currency of another non-dollar country, primarily they exchanged their own currency for dollars and then used those dollars to purchase the other currency desired.

Thus, for example, if a Liberian resident desired to but French francs, he might have exchanged his Liberian dollars first, for American dollars, and then those dollars for francs.

Even though IMF members must have maintained their rates of exchange within 1 percent of parity in either direction against the dollar under the system that prevailed until 1971, the dollar itself, under the original IMF agreement, need have been kept convertible into gold only when it was presented by member countries' official financial institutions.

Say, if the escudo-dollar rates fell or rose by more than 1 percent of parity, it would have been up to Portugal to take corrective measures and not the united states. For those reasons, the United States was obliged to maintain certain gold reserves, but only smaller reserves of foreign currencies.

The crux of that system was this undertaking to provide gold when requested; of course, other countries were expected not to turn in their dollar holdings capriciously.

Dollars usually became internationally available when the United States ran a deficit on its balance of payments, which gave the unfortunate illusion of a permanent necessity for such deficits. Other currencies, especially sterling, are also used as components of reserves, and conceivably their use could be substantially increased. But given the gold convertibility of the dollar until August 15, 1971, and the economic size of the United States, the dollar was heavily demanded in the past for reserve purposes.

It might possibly be said, therefore, that until the advent of the SDRs, the United States was 'obliged' or 'condemned' to incur deficits if the international monetary mechanism was to avoid a crisis of liquidity.

The deficits have placed a strain on both the dollar exchange rates and the U.S. monetary gold reserves. Although the United States is not necessarily obliged to defend the dollar exchange rates, it has done so from time to time when they have been under heavy speculative attack. It has taken that action with the cooperation of other central banks.

Moreover, with regard to the downward pressure on dollar rates of exchange, some foreign countries have, from time to time, lost confidence in the stability of the dollar, the dollar exchange rates, and the continued ability of the United States to redeem foreign official dollar holdings in gold.

That lack of confidence has been manifested, in part, by substantial requests for the redemption of foreign-held dollars, in gold. As a result, the monetary gold holdings of the United States, which stood at almost $25 billion in 1947, have declined to about $10.2 billion (November 1971).

An international monetary system that relies on U.S. balance of payments' deficits and weakens its principal reserve currency by reducing the U.S. gold reserve is not an indefinitely viable one. It was the hope of the IMF and the majority of its members that the SDRs would improve the international monetary system by reducing the responsibility and pressure that the system imposed on the dollar.