Home Money & Finance Why Is USD the Most Popular Currency in the Forex?

Why Is USD the Most Popular Currency in the Forex?

by Olufisayo
Most Popular Currency in the Forex

The US Dollar is one of the most popular currencies among forex traders. It is estimated that over 85% of the daily traded volume in the forex market is done in USD.

The popularity of the USD is because it is widely accepted all over the world as the reserve currency. About 60% of the foreign currency reserve by central banks around the world is in USD while Euro accounts for about 27%.

Here are some of the reasons why the USD is popular in the forex market.

Major Forex pairs are Quoted against the USD

In the forex market, major currency pairs include currencies from the developed nations quoted against the USD. Forex traders prefer the major currency pairs due to their higher liquidity and low volatility. Some of the major pairs include EUR/USD, GBP/USD, AUD/USD/ USD/CAD, USD/CHF, USD/JPY, and NZD/USD.

For forex pairs that have the USD as the base currency, their exchange rates are referred to as direct rates. That’s because the domestic currency is the pricing currency. Forex pairs with direct quotes against the USD include USD/CAD, USD/JPY, and USD/CHF. More so, major indices like the US30 or the US500 are also priced in USD.

       

The USD accounts for about 86% of the daily forex turnover. According to the Bank for International Settlements (BIS), trading in the EUR/USD pair accounts for about 27% of the daily forex turnover, and the USD/JPY and GBP/USD accounting for about 13% each.

The main popularity of the forex pairs traded against the USD is that they remain liquid for the most part of a trading day. However, their liquidity significantly increases during the North American forex trading session between noon GMT and 10.00 PM GMT on weekdays.

In the international market, commodities are priced in USD. Furthermore, leading commodity exchanges in the world, such as the Chicago Board of Trade price their commodities and commodity derivatives in terms of USD. Similarly, when trading commodity derivatives, like Platinum trading, through online CFD brokers, you’ll notice that they are all priced in terms of the USD.

The USD is the Strongest Currency in Forex

When we say it is the strongest currency, we don’t mean that it’s the most expensive currency in forex. It means that the value of the USD is supported by the underlying economic fundamentals of the US.

It has the highest GDP globally and is one of the biggest participants in the international, which makes the demand for the USD higher. The US alone accounted for about 20% of global transactions. That makes it by far the largest participant in international trade.

       

Furthermore, the health of the US economy has remained relatively stable over time, which means that the value of the USD has also remained stable. The US Federal Reserve has managed to keep the rate of inflation in the US within acceptable levels.

Thus, international investors can therefore rely on the fact that the Federal Reserve will not engage in manipulation of the USD nor devalue it. This relative stability in its value is why it is preferred as the currency of choice for reserve assets.

The USD is the Global Reserve Currency

A reserve currency is a foreign currency that is held by central banks across the world for purposes of repaying debt or stabilizing the local currency in the forex market. Globally, 40% of international debts are

denominated in the USD. According to the IMF, about $6.8 trillion worth of USD is held as a reserve currency globally.

Some of the main features of a reserve currency are that they should have sufficiently high liquidity to enable seamless international transactions. Reserve currencies are also universally accepted.

       

The rise of the USD began with the Bretton Woods Agreement of 1944. The gold standard was abolished, and the exchange rate for all currencies was pegged on the US dollar.

International Lending Standards

As mentioned earlier, over 40% of all global debt is denominated in the USD. When lenders issue debt in the form of USD, it means that debtors have to pay the interest and repay the principal in USD.

This trend is perpetuated by top global lenders like the International Monetary Fund and theWorld Bank. These institutions issue almost all of their loans denominated in the USD. This practice has ensured that the USD is traded continuously in the international markets.

As explained earlier, the preference for the USD is owed to the relative economic stability in the US. Lenders have faith that the value of their money will not be eroded during the duration of the loan. This confidence is due to the stability of the rate of inflation and transparent accountability of the Federal Reserve.

Conclusion

USD is the most popular currency in the world. In the past, some of the leading economies have proposed the creation of a global currency to replace the USD.

       

It has been argued that the status of the USD as a global reserve currency should be reviewed. The reasons behind this are:

  • In the recent past, there has been excessive public spending by the US government through quantitative easing measures. It is feared that such fiscal expansionary policies may lead to excessive inflation of the local currency
  • Endless expenditure on what is termed as endless wars overseas. The cost of funding these wars come at the expense of funding other economic ventures
  • The increasing budgetary deficits in the US has led the USD to lose its value in the long run steadily. Furthermore, there has been an increasing drop in confidence in the US and the USD internationally.

Notably, some of the global economies have been systematically reducing their reserves of the USD in favor of gold. Although the USD still dominates as the worldwide reserve currency, its dominance has been dropping over the past two decades.

In 1999, the USD accounted for about 70.9% of the global reserve currency to 62 % in 2009 to the current 60%. During this period, there have been marginal increases in the EUR and GBP. Cheers!

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