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The story of the US dollar cannot be told without talking of the wars the USA has fought. Most of the early US dollar bills were printed to finance conflicts, internal or external. In the 20th century, it was World War 1 that facilitated the dollar’s rise to the position of a global currency. One of the war's aftereffects was that the sun began to set on the empire that once boasted it would never see a sunset, and began to rise to the zenith over its erstwhile colony. This shift in fortune also reflected in the pecking order of the currencies, with USD gradually replacing GBP as the global currency standard.

The next World War completed the transition. The entire Europe was in shambles by the end of WW2 and the USA became the undisputed global superpower, financial and military. This new stature of the USA and US dollar was formalized by the Bretton Woods agreement that anointed US dollar as the official global reserve currency in 1945. Thus started the dream run for the US dollar until another war nearly wrecked the show.

It was 1970 and the long-drawn out Vietnam war had started taking a big toll on the economy. The European nations that had put money in US treasuries were getting increasingly worried about USA’s finances. The nobility conferred to USD by Bretton Woods came with certain obligations, the main one being the obligation to repay the dollar debts in gold, if demanded by the lenders. As nations started suspecting USA’s debt servicing capacity, many scrambled to exchange their dollars for gold, until Nixon put a stop to the gold-rush by going off gold standard, effectively devaluing the currency and reneging on the main covenant. This naturally raised the hackles of the affected countries who found themselves short-changed, but instead of trying to mollify them, the US Treasury Secretary John Connally famously barked at them, “dollar is our currency but your problem”.

Such insult, coming on top of the earlier injury of delinking from gold, could have ended the career of the dollar as global currency, but for two wars, one cold and one hot. It was the peak of the cold-war and the western nations saw Russia as the big bear breathing down their necks. They needed the USA on their side, a dependency that contributed to the arrogance of the USA in the above exchange and its meek acceptance by the Europeans. The second was the 1973 Yom Kippur war between Israel and the Arabs. The Arab nations were forced to enter into a peace treaty with Israel at the end of the war. They realized their future safety and security depended on maintaining strong ties with the USA. Saudi Arabia led the way and signed an agreement with USA whereby USA committed to provide security cover to them and in return SA undertook to invoice all their oil trade in dollars. That was the beginning of a wonderful friendship of sorts. It enabled USA to monetise its military heft and create a dollar hegemony, it gave peace of mind to the Saudis by having the world’s topmost power guard their gates. The petro-dollars that came out of the arrangement transformed USD into a truly universal currency and also helped USA to expand its borrowings to such extraordinary levels that has no parallel in modern economics. It was a master-stroke beyond compare, by any measure!

But like all good things, this one is also nearing an end, thanks to the latest war the USA started but could not finish. The war may not have a clear victor, but Arab countries clearly lost. They learnt at considerable cost and pain that the so-called security guarantee failed to work the way it was intended. In real crux situations the USA was seen to be more concerned with the safety of its own people and the safety of Israel, with little inclination to walk the talk as far as the commitments to the Arab allies were concerned. Such behaviour may not have been altogether unexpected, but that doesn’t make it any less hurtful. Arab nations may continue invoicing in US dollars for some more years out of sheer force of habit, but the gordian knot tying oil to the dollars is going to be cut off for good, eventually.

This doesn’t mean the US dollar will become an underdog overnight, it will still be a very important currency, but there is a big difference between being the sole global currency and an important global currency and that will show in the currency’s fortunes. Besides, there will be second order effects that will accelerate the change. US debt has already reached a level that is unsustainable even for USA. The present US debt is close to USD 39 trillion and the direct and indirect war costs may add another 1 trillion to the figure. As against this US GDP is around 30 trillion dollars, or around 75% of the debt. Worse still, US debt is growing at above 6% per annum while the GDP may at best grow at 3%, so within a few years, the ratio will turn much worser. On top of this, the higher inflation driven by war and tariffs means the new debt and rollovers would be at higher costs. The latest US inflation is at 3.3% much higher than the acceptable level of 2% and it is likely to stay in this territory for some time.

In short, things are not looking too good for the US dollar, but there is a saving grace. There is nobody else around to take over the crown. Chinese Yuan may fancy itself as a contender but the world trusts China even less than it trusts USA. So, the currency crown may, somewhat uneasily, continue to lie on the head of the US dollar, for a while. But eventually a day will come when the world will find itself being more wary of the US dollar than its alternatives. That day may come in five years or after fifteen years but it will come for sure, unless US starts another war in the interim and manages to win it hands down. Until one of these things happen, we have no option but to keep saying, Dollar is Dead, Long Live the Dollar, while getting ourselves ready for the change, as and when it comes.