Financial Advisor

The dollar, 150 years old and vulnerable

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The US dollar, which turned 150 this week, is finally starting to act its age. After a stormy childhood, it spent much of its 20th century prime as the unquestioned linchpin of global finance, particularly during the Bretton Woods era, when it was tied to gold. Today, the greenback is the primary reserve currency, largely due to tradition and lack of alternatives. With traders unwilling to bet on the troubled euro and unable to bet against the renminbi, gold's nominal record in dollar terms this week shows unease about the dollar's long-term strength.
In 1861, people getting paid in the untried new paper currency initially were wary, sending its value sharply lower versus specie. The phrase "not worth a Continental" – a reference to paper dollars issued to finance the Revolutionary War eight decades earlier – showed their skepticism about fiat currency. They feared the dollar, created to finance the Union's war against 11 rebel states who had issued their own dollar three months earlier, would suffer the same fate.
In fact, the dollar almost vanished several times. Yet the flowering of the US economy in subsequent decades, and the need for liquidity during panics, revived its fortunes. The longer it hung around, the more it became accepted as "legal tender". Federal Reserve notes, a 20th century development, eventually replaced original greenbacks backed by the Treasury, but the name stuck.
That was 40 years ago – the same year that the dollar's link to gold was severed. Hard-money types say that began the dollar's decrepitude, but perhaps they are wrong. US economic decline might easily have been quicker if the Federal Reserve under Paul Volcker had not restored faith in the dollar in the 1980s. Even backed only by faith, memories of the greenback's prime bought the US a few more decades of the good life. Now old and frail, the dollar is worryingly vulnerable to a nasty fall.

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