Why Has The US Dollar Stayed Strong Despite The COVID-19 Crisis?

Lately, every time the investors' optimism on the world's efforts to contain the coronavirus has ebbed, the US dollar has gained.

While the Indian rupee has been falling to new all-time lows on weak stock market sentiment, the American currency has remained strong despite skyrocketing unemployment, the highest number of COVID-19 cases and possibly contracting GDP in the US.

At one point, the dollar index rose 4 percent after the COVID-19 crisis. The dollar index is used to measure the American currency against a basket of 6 major currencies-Euro, Swiss Franc, Japanese Yen, Canadian dollar, British pound, and Swedish Krona. At the peak of the crisis at the end of March, the dollar rose against the British pound sterling to its strongest since 1985.

The US dollar has remained strong despite threats to its economy because it is considered a safe-haven asset amid unpredictable crisis like the pandemic that we are now facing.

What is a safe haven?

A safe haven is an investment that is expected to either retain its value or increase its value during times of uncertainties that cause turbulence in capital markets. You may have observed that investments like gold (also a safe haven) increase in value when stock markets experience volatility.

Gold is an ideal safe haven because it is considered valuable universally, it is not governed by any government and is unaffected by interest rate decision of any economy.

Some currencies are also considered a safe haven and valued higher for their stability over other currencies. For example, Swiss Franc is a safe haven because Switzerland's stable government and financial system which has a foreign policy that affirms "perpetual neutrality" within the international community.

Similarly Euro, Japanese Yen and US Dollar are also considered safe havens due to their advanced economies, but the American greenback has become the most accepted currency in the world.

From big international business deals to street vendor shopkeepers, USD is the most acceptable value of exchange.

How did the US dollar become a safe haven?

The American dollar is a default safe haven for many companies and governments since it is the world's reserve currency and the preferred denomination for many international business deals (like for purchasing crude oil).

Today, over 60 percent of all forex reserves maintained by central banks (including RBI's) are denominated in US dollars, and nearly 40 percent of the world's debt is in dollars.

How did the US dollar become the world reserve currency?

After the Federal Reserve (USA's central bank) was created in 1913, the US overtook Britain as the world's largest economy. During the time, most transactions were valued in pounds and the gold standard was used to peg the value of currencies. The gold standard, which is no longer used, meant that a country's currency or paper money was directly linked to the amount of gold it held.

During World War I, Britain found itself having to borrow money for the first time and eventually abandoned the gold standard, decimating bank accounts of international merchants who traded in pounds. The dollar then replaced the pound as the world's leading reserve.

The US also served as the main proprietor of weapons, supplies, and other goods for the Allies during the two World Wars wherein it collected much of the payment in the precious metal and the country ended up owning the vast majority of the world's gold.

In 1944, delegates from 44 Allied countries signed the Bretton Woods Agreement wherein it was decided that the world's currencies couldn't be linked to gold, but to the US dollar, which was linked to gold.

Present day US dollar

As central banks started purchasing gold in exchange for the dollar, the stability of the greenback was questioned. As a result in 1971, the then US President Richard Nixon de-linked the dollar from gold, which brought about the floating exchange rates that exist today.

Despite periods of high inflation and high unemployment in the US, the dollar has remained the world's reserve currency largely due to the size and strength of the country's economy and its dominance in the financial markets.

Even with large deficit spending, trillions of dollars in foreign debt, unbridled printing of the American currency, US Treasury securities are considered risk-free storage of money due to the confidence in the US government to pay its debts.