Power of Dollar and Federal Reserve

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Dollar is the Alpha and the Omega when it comes to currency markets. In short dollar brings in the full might of the most powerful country on earth and has the backing of the biggest central bank in the world, The Federal Reserve. Now, predominantly it was gold that initially dictated the fate of various currencies after the Bretton Woods agreement. But after the Nixon shock, the gold standard was let go and currencies were traded in a free float format that is present till this day.

If we look at the main reason for the world to move on from the gold standard comes down to the fact that there is not much physical gold in the world. All the gold present, if melted and poured in Olympic swimming pool size reservoirs, the reservoirs filled will only be three.

This scarcity of physical gold became the biggest hindrance in global free trade and circulation of currencies. So, instead of being pegged to gold, dollar became a market free float currency. This type of currency derives its value from the demand they possess in the market. Thus, if the central bank that prints the currency has strong fundamentals, the currency demand is high. After the initial depreciation of dollar after conversion into a free float currency, it has become the currency that everyone runs to in the time of crisis.

The values of other currencies come from the inflow of dollar in the country. So, after Brexit as anticipated that the UK will take an economic hit, dollars started flowing out of UK which led to the depreciation of GBP.

China with their managed currency, depreciates the Yuan by buying dollars from the market and circulating more Yuan in the market. By this act of buying dollar an artificial demand is created for US dollar and buy increasing the circulation of Yuan an artificial heightened supply of Yuan is created leading to Yuan been depreciated against dollar.

In conclusion, the policies of the Federal Reserve have always driven the demand of dollar against other currencies and will remain to be so in near future due to the fundamentals of the institution. For any person it is very important to know about how the world is functioning and what better way is there to do this than to understand economy and the various aspects it depends upon.

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