Readers Question: Why do foreigners often hold U.S. dollars? How does the holding of dollars by foreigners affect the welfare of American?
The Dollar still is the world’s reserve currency. With about 67% of the world’s currency reserves held in dollars. Up until the First World War, the British Pound was the most widely accepted currency. But, after the First and Second World War, the UK economy fell behind its main rivals and the US become the dominant economic and political power.
Reasons people hold and use US dollars outside the US
- Historically, it has been seen as a safe, secure and strong currency.
- Because most other people hold currency in dollars, people may think there is strength in numbers.
- Most commodities are priced in US dollars. Commodities such as oil and gold are priced in US dollars, so this gives an additional reason to hold currency in US dollars, minimising transaction costs of getting dollars to buy commodities.
- China buys US Dollar assets to keep its currency undervalued. By keeping dollar undervalue, it makes Chinese exports more competitive and helps to boost export demand. See: Chinese currency manipulation
- Problems in Eurozone have made the US more attractive than many Euro bonds.
- Protect against domestic inflation. If you live in a country with a history of inflation, then holding US dollars is a way to protect the value of your savings. If you have a domestic inflation rate of 20%, then the value of cash savings will fall quickly. But, if you hold US dollars, then the currency will tend to be linked to inflation. If Argentinian inflation is 20% higher than the US, then the Argentinian currency will fall by an equivalent rate. If you hold US dollars you will be able to convert to more Argentinian currency after inflation.
- The official or parallel currency. After a period of devastating hyperinflation, Zimbabwe felt the only way to tackle the crisis was to revert to using the US dollar. This ended inflation straight away.
- The US dollar is accepted worldwide. The Russian or Chinese currency may not be accepted worldwide, but nearly everywhere is willing to accept the US dollar. For some high-value luxury purchases, firms may only be willing to accept the US dollar. It is estimated that as much of as 80% of all transactions in Asia are made in dollars – and this is higher for luxury items like cars.
- Some countries like Panama and the Bahamas have a dual currency