You will often hear about the unique position of the US dollar as the reserve currency of the world.
What does it actually mean? And why does it matter? Here, I will be answering these questions in very simple words.
When a country wants to strengthen its currency, it has to increase its interest rate. A high-interest rate squeezes the money supply and, hence, increases the value of currency. But a high-interest rate hurts the economy. It slows down output and increases the unemployment rate. This is why strong currency comes at the expense of a slowing economy.
The best part of the dollar story is that it is used as a reserve currency by central banks and sovereign wealth funds. This is where the sweet story begins.
When central banks and sovereign wealth funds invest their money in government bonds, the US interest rate gets lowered. So, you get a low-interest rate and a strong currency at the same time. This is a unique privilege enjoyed by the USA.
On top of this, the stock market and property prices remain robust. Crowning them both, the US government can now print a strong dollar at a cheap interest rate and fund government financing. And as long as international trade is growing and the dollar keeps its hegemony, they can keep doing it at a certain level for the foreseeable future.
This is why Russian President Vladimir Putin once said, “Yes, we depend on oil and gas, but we don’t have a money printing machine like the USA. They can depend on printing money.”