The almighty dollar

On July 6th, 1785, the US Congress unanimously decided that the name of the US currency would be the "dollar" and adopted a decimal subdivision of it.

Count Hieronymus Schlick of Bohemia had minted high quality silver coins known as Joachimstalers, named for Joachimstal, the valley where the silver was mined. The German word for valley is thal, pronounced tal. Joachimstaler was later shortened to the German ‘taler,’ which became ‘dollar.’ The coins circulated widely in the American colonies, and were respected for their quality and reliability.

The Coinage Act of 1792, specified a "dollar" to be 371 grains and 4 sixteenths part of a grain of pure silver. Alexander Hamilton decided to base it on the average weight of worn Spanish ‘dollars’ (pieces of eight), and weighed a sample of them to come up with the 371 figure.

The familiar greenback dollar bill was tied to precious metals until 1971, when President Nixon suspended the convertibility of paper money into bullion, making the dollar a fiat currency like most others. This means it has value because the US government says it does, and because people have confidence in it. Given the world dominance of the US economy, and the widespread use of the dollar for international transactions, the US dollar is the world’s leading reserve currency.

One of the key motives behind the creation of the Euro was the resentment in parts of Europe, especially France, at what they perceived to be the ‘unfair’ advantage the dollar’s position gave to America. They wanted the new currency of the EU to be able to stand up to the dollar, and maybe even replace it as the world’s primary reserve currency.

In fact some countries outside the US, especially in the Caribbean, use its dollar as their official currency, and in many others it is accepted de facto as an alternative, usually a preferred one. People’s acceptance of it is ultimately based on their trust in the US government and its Federal Reserve Bank. Even a currency tied to gold and silver, as the US dollar used to be, is promissory, in that people trusted that the government would exchange the notes for bullion if requested.

British banknotes say “I promise to pay the bearer on demand the sum of X pounds,” but if you take one into a bank, even the Bank of England, they will only give you another banknote of equal value in exchange.

A problem for those who want currencies tied to gold is that there is not very much of it. All of the gold ever mined in history would only fill up about one third of the Washington Monument. And the gold supply cannot be increased at a steady rate to match the increase in productivity and growth, generally reckoned to be between 1 and 2 percent per year, and at the upper end of that range. The Bank of England’s Governor is required to send an open letter to the Chancellor when inflation goes above 2 percent. Had bullion-backed currencies been the norm at the time of the 2008 Financial Crisis, it would not have been possible to do Quantitative Easing, and a worldwide repeat of the Great Depression might have resulted.

It would be nice if there were a clear solution to the problems that confront fiat currencies, but there does not appear to be an obvious one. It seems that governments must respond to crises on an ad hoc basis, learning from what has or has not worked before, and treading very carefully. For the moment it is the dollar that ultimately underpins the global economy, and we have to hope that those who control it will do so responsibly.