IT’S BACK. The prime sign of American supremacy has rebounded over the past year, much to the consternation of its detractors. The dollar, left for dead only a short while ago, is on a roll, and it looks unstoppable for the foreseeable future.

The greenback’s long rise to premier status says much about the nature of a global reserve currency and its own remarkable staying power in that role. U.S. currency first began to acquire this position in the 1920s, largely because the First World War had crippled Europe economically and brought the United Kingdom, whose pound sterling had held the role for much of the previous century, to the brink of bankruptcy. But even then, the greenback did not dominate. For decades, it shared with the pound its status as a preferred medium of international exchange, sometimes gaining prominence, sometimes losing it as the policies and economic prospects of the two countries varied. Only after the Second World War did the dollar accumulate all the qualities needed for an unchallenged position, something the 1944 Bretton Woods conference acknowledged when it designated it as the global reserve.

Much of what supported this preference for the dollar was far from new and was based in long-established habit and practice. The tremendous growth of the U.S. economy since the late nineteenth century and its expanding trade links had accustomed people across the globe to dealing in dollars. Businesses, individuals and governments had established institutions and practices around that custom. The greenback had for decades been commonly available as an exchange medium in just about every major city and port from Asia to Europe to Latin America. People had long written import and export contracts in dollars, as well as the loans made to facilitate those deals. The prominence of the currency had for years led businesses, financial institutions and central banks to hold significant dollar deposits and investments as a matter of course.

In addition, the dollar’s rise in the late 1940s reflected the unparalleled security it offered. The United States and its currency had become the safe haven par excellence. It possessed a large, strong economy, along with unrivaled production prowess. The United States also offered political stability, especially rare at that time. It promised prudent fiscal and monetary policies and little danger of disruptions from radical swings to either the left or the right. American diplomacy and military power gave confidence to others that the country could and would protect its interests (including the dollar) anywhere. America’s reputation as a nation of laws further promised that it would meet its obligations and that any wealth anyone placed in dollars, wherever its owner lived, was secure from arbitrary taxation or expropriation. The Bretton Woods agreement added to the dollar’s appeal by linking it to gold, the traditional reserve going back to classical times. That, combined with the promise of prudent policy, assured people that the currency would hold its purchasing power, or, as economists like to say, made it a secure store of value.

One other crucial quality rounded out the greenback’s unbeatable résumé. The United States offered the world broad and deep capital markets. This gave the currency an essential edge by presenting its varied holders with an array of financial instruments in which to place their holdings, some offering security, some liquidity and still others higher potential returns, perhaps at the expense of security or a measure of liquidity. Through their immense size and ceaseless activity, these markets further promised anyone worldwide that they could convert their dollar investments quickly into spendable cash and then, just as quickly, convert that dollar cash into other currencies or gold. Because these markets also traded actively in futures and options, they offered dollar holders a welcome way to hedge against the risk of any fluctuations between the greenback’s value and commodities, such as gold or copper or foodstuffs, or, critically, between the dollar and their home currency or any currency in which they faced liabilities.

During the twenty-five years following the Second World War, these impeccable credentials left the dollar unchallenged. Its only shortcoming emerged, ironically, from the American economy’s overwhelming relative strength, which created a net trade surplus with the rest of the world. Ideally, the country issuing the reserve currency should run a deficit. Buying more from the rest of the world than selling to it would create a natural flow of reserves onto global markets that could meet the growing liquidity needs of expanding world trade. This dollar shortage, however, began to disappear in the late 1960s, as improving competitive abilities abroad put American foreign trade into deficit. But while that development solved an international financial problem, it laid the seeds of the system’s demise by creating a domestic one. U.S.-based producers, unaccustomed to competition, chafed as foreign firms, especially Japanese and German, pushed them out of markets, both foreign and domestic, that they had once dominated. Then President Richard Nixon felt the political pressure and sought to relieve it by altering the fixed foreign-exchange rates set by the Bretton Woods agreement. When Germany and Japan resisted, Nixon acted unilaterally and, on August 15, 1971, severed the link between the dollar and gold.

Yet, the greenback retained its position as the global reserve. To some extent, its resilience reflected the influence of that long habit from prior years and the institutional arrangements established around it. The currency continued to be dominant in most international trade and banking arrangements. Though the dollar lost bragging rights as a secure store of value, few other currencies could claim a superior record. Some had indeed gained against the greenback, but almost all countries suffered as severe inflation as the United States. In other respects, alternative currencies had still less to offer. Some, to be sure, had elements required of a global reserve. By the 1970s, many more nations could claim political stability and the rule of law than in the late 1940s. None, however, had anything approaching America’s diplomatic or military reach, the size of its economy or the scope of its trade. U.S. financial markets, too, contributed to the dollar’s ability to retain its status. Only London could rival their depth, breadth, liquidity and versatility, but the pound sterling by this time lacked many of the other elements required of a reserve.

SINCE THEN, the relative position of the United States has deteriorated further. The dollar has continued to lose foreign-exchange value against the world’s major currencies (if not in recent years, then certainly on balance over longer stretches of time). The United States remains the world’s largest economy, but not nearly by the margins that once prevailed. China rivals America’s trade reach, and even German trade is relatively greater than it was in the 1970s. The euro zone, of which Germany is a part, certainly approaches the scale of America’s economy and volumes of international trade. Questions have arisen about Washington’s diplomatic and military reach, while its budget deficits and financial turmoil have raised more questions than ever about the prudence of U.S. policy. Some have even voiced doubts about Washington’s ability to meet its financial obligations. As if to underscore all these signs of American weakness, in 2011 Standard & Poor’s downgraded its assessment of the creditworthiness of the United States.

Now China has actively begun to attack the dollar’s position. Officials in Beijing have openly declared their objective, stating ominously through the country’s official news agency Xinhua that “it is perhaps a good time for the befuddled world to start considering building a de-Americanized world.” At the February 2014 meeting of the G-20, Chinese representatives accused the United States of abusing the dollar’s reserve status and merely living off printed money, with nothing to back its prosperity. Beijing has gone well beyond rhetoric, too. It has pressed Chinese firms, both state owned and private, to use yuan instead of dollars in cross-border transactions. At last count, some seventy thousand Chinese companies had complied. Beijing has signed agreements with Japan, Russia, India, Brazil, South Korea, Saudi Arabia, the United Arab Emirates and others to conduct their bilateral trade in their own currencies instead of dollars. As Africa’s largest trading partner, China has also successfully promoted the use of yuan in trade there.

Yet for all this activity and striving, the dollar remains securely dominant. It is by far the world’s most traded currency, involved in 87 percent of all global currency exchanges, up from 85 percent in 2010. The euro is the next largest at a distant 33 percent, with the yen at 23 percent and the pound at 12 percent. The yuan, though up quite a bit from its 0.9 percent in 2010, is still only involved in 2.2 percent of all global currency trades. Almost 90 percent of the world’s trade contracts, totaling over $5 trillion a day, are denominated in dollars, whether an American is involved or not. By comparison, the yuan constitutes an equivalent of about $100 billion a day, or only 1.5 percent of global volume. And when the yuan is used, there is always a Chinese party involved. The International Monetary Fund (IMF) reports that dollars still make up more than 62 percent of the reserve holdings of the world’s central banks, down only slightly from 71 percent in 2000. The euro is far behind in second place at 23 percent of the total, up only slightly from 18 percent in 2000. The pound sterling and the yen comprise merely 4 percent of such holdings each. In this regard, the yuan does not even rate mention.

THIS REMARKABLE resilience is hardly a credit to American economic or financial management. Nor is it a vote of confidence in the country’s economic strength or its financial health. Nor does it detract from China’s growing economic or trade stature, or those of other economies. Rather, it stems simply from the recognition that, despite America’s relative decline and the relative gains of others, no other currency comes close to the dollar’s credentials for the position of global reserve.

Consider the list of potential contenders. The incapacity of the ruble is evident. The pound sterling has some positive attributes, including an issuer with the requisite political stability and rule of law. Britain possesses sufficiently large and well-developed financial markets as well. But the pound loses out on other fronts. The British economy is too small to support a reserve currency, as is the reach of its trade, its diplomacy and its military. Tokyo’s yen is no contender either. Though Japan’s economy probably is sufficiently large, as is its trade, and its financial markets are close to adequate, its lack of dynamism raises questions about the yen’s ongoing backing from the production of goods and services. Tokyo’s lack of diplomatic and military stature raises additional questions about its ability to secure its and the yen’s interests. Besides, Japan has always resisted such a role for its yen, even when it looked like a world-beating economy. The country’s heavy dependence on exports has always led it to rely on a cheap yen to give its goods and services attractive pricing on global markets. Accordingly, Tokyo has chronically feared the yen appreciation that would naturally accompany reserve status and the increased demand for yen it would engender.

The euro has much to recommend it. The euro zone lives under the rule of law. The euro remains more widely held, in central banks and elsewhere, than any currency except the dollar. Its financial markets are large and well developed enough for the role. They rival dollar-based markets in scope, if not quite in absolute size or levels of activity. Outside finance, the euro zone’s economy and the reach of its trade also bear comparison to the United States. Europe’s financial crisis, however, presents a major obstacle, raising crucial questions about the currency as a secure store of value. To be sure, the euro’s foreign-exchange value remains relatively stable, remarkably so under the circumstances. The crisis, however, poses deeper questions about whether the common currency will even survive and, if it does, how many countries will continue to use it. Until such issues are resolved, the euro as a global reserve is a dead letter, and the depth and extent of the crisis suggest that such a resolution will take a long time indeed.

China’s yuan, despite the headlines, faces even greater impediments. Of course, the country’s economy is large and dynamic enough. It is significantly larger than any alternative except the euro zone. The reach of its trade is disproportionally greater, already approaching that of the United States. But there are serious questions about political stability and certainly about the rule of law. Nor can China’s diplomacy or its military claim a global reach. Though China has assumed a higher profile in East Asia, even a bullying one, it seldom ventures out of its region. When it does, much like Europe, its diplomacy mostly supports trade. Apart from oil, China plays no role in the Middle East. Apart from raw materials, it plays no role in Africa or the Americas.

It is in the financial realm, however, that the yuan’s biggest failings exist. Its markets are much too closed to support a global reserve currency. Though Beijing talks a great deal these days about liberalization, it still refuses to allow foreign financial institutions to operate freely in China and continues to control financial flows into and out of the country. The yuan remains only partly convertible for financial transactions. Nor is Chinese finance nearly well developed enough. It has neither the array of financial vehicles necessary for the task nor the trading volumes to provide the requisite liquidity. As of 2013, economist Jonathan Anderson told the Wall Street Journal, China reports the equivalent of some $250 billion in financial instruments available to international traders, bankers and investors. That figure pales next to the $9 trillion equivalent of sterling-based financial instruments, the $15 trillion equivalent in yen or the $29 trillion equivalent in euros. And it is less than 0.5 percent of the $56 trillion in dollar-based instruments available. It speaks volumes that the yuan’s oldest and best-developed trading hub in Shanghai recently boasted that it can now trade yuan directly into eleven other currencies. That is progress, but a reserve currency needs to give traders the ability to move into and out of every other currency in the world in enough locations to keep markets liquid around the clock.

CHINA MAY not even want global reserve status for its yuan. To be sure, Beijing can see the immediate benefits of a more internationalized currency. It can also see the potential benefits from a further elevation into premier reserve status. But it is well aware that reserve status also carries disadvantages that would burden China unduly at this stage in its development. It would, after all, require open financial markets and hurt Chinese export potential by adding significantly to the foreign-exchange value of the yuan. Rather than seeking to displace the dollar, it could well be that China and many of the other countries that have recently attacked the dollar’s dominance simply want those initial benefits of internationalization that the dollar’s preeminence has heretofore denied them. They can wait for the next step to premier reserve status, if they intend to reach it at all.

An international profile for a currency, even well short of global reserve status, does certainly have appeal. At the very least, the government involved gets prestige that it would not otherwise have, something with great attractions for the self-conscious lot in Beijing and especially for postcolonial emerging economies. It is noteworthy in this regard that the BRICS economies (Brazil, Russia, India, China and South Africa), when they established their bank in competition with the IMF, explicitly referred to their frustration, even anger, over their exclusion from the fund’s decision-making apparatus. One negotiator noted at the time of the announcement that, by some accountings, the BRICS economies combined are almost as large as those of the United States and the European Union, but they have far fewer votes at the IMF. Beyond prestige and influence, a currency’s international presence and overseas holdings also offer an appealing flexibility to macroeconomic policy, particularly monetary policy, by blunting any unwanted immediate effects of policy changes on trade conditions.

Internationalization makes trade cheaper and less cumbersome as well. When a country’s importers and exporters can trade in their own currency, they avoid the risk of adverse foreign-exchange moves during the deal. Contracts in dollars expose Chinese exporters, for instance, to foreign-exchange shifts that could bring down the yuan value of their contracted dollar payments relative to their yuan-based domestic production costs. They can, of course, hedge against such risk by buying yuan futures against the expected dollar payments. But such financial maneuvering has a cost, as does the need to convert into and out of dollars. It could well be that all the bilateral agreements to trade away from the dollar are less about unseating the dollar and more about simply making business cheaper and easier to transact while perhaps gaining some prestige and policy flexibility in the process.

These nations, especially China, are no doubt also sensitive to the additional advantages of moving up from internationalization to reserve status. They can see that the dollar’s dominant reserve status allows the United States to buy many more goods and services from the rest of the world than it sells. The willingness of foreigners to hold the global reserve allows Washington to make up the difference effectively with paper. Because these foreign dollar holdings typically find their way into U.S. Treasury bonds, the dollar’s reserve status allows the U.S. government to issue more bonds and get more credit from the rest of the world than it otherwise could. It was the recognition of these ways in which the United States could live beyond its means that prompted Valéry Giscard d’Estaing in the 1960s to describe the country as possessing an “exorbitant privilege.” Governments in China, Russia and elsewhere cannot help but covet such advantages. But China’s leaders in particular are well aware of those problems that would also accompany reserve status.

DESPITE ALL of the dollar’s relative advantages and all the disadvantages of its competitors, there is still every reason to expect that in the fullness of time some other currency will seriously challenge the dollar’s status. In that distant future—perhaps when China has reoriented its economy, developed and opened its financial markets, assumed a truly global diplomatic and military presence, and learned to live under the rule of law—it may be the yuan. It may be the euro, when the euro zone has finally remedied its financial failings and overcome the other impediments standing in its way. Or it may be a currency not even considered today. Whichever currency rises to the challenge, that day is clearly still a long way off. Even then, if the last change of global reserve is any indication, the supplanting will take still longer, during which time the dollar will likely share reserve status with its ultimate replacement, as the pound sterling did with the dollar in the early twentieth century. For now, the dollar reigns supreme.

Milton Ezrati is senior economist and market strategist for Lord, Abbett & Co. and an affiliate of the Center for the Study of Human Capital at the State University of New York at Buffalo. He is the author of Thirty Tomorrows: The Next Three Decades of Globalization, Demographics, and How We Will Live (Thomas Dunne Books, 2014).

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