Why is international trade conducted in the US dollar?

International trade is conducted in US Dollars due to a couple of accidents named world wars.

Prior to those accidents trade was conducted in gold, disguised as the various national currencies under the gold standard, with the Pound Sterling being the most liquid, stable, and valuable among them, as a consequence of its deep financial markets and vast overseas investments.

The British Empire was then the world’s creditor. I shall try to make a long story short.

World War I requested an immense financial effort to all belligerents, draining their treasuries dry. The Allied countries, with no exception, turned to the United States both for finance and for procurement (on credit) of matériel of any denomination.

The US had been hitherto a very provincial market, with wild gyrations in interest rates and demand for money linked to the agricultural cycles (Goodhart, C. The New York money market and the finance of trade, Harvard University Press, Cambridge, 1969, among others).

Once the US entered the war it tapped its vast pool of resources, both with Liberty Bonds and tax, in order to sustain its and its allies’ war effort. Some estimated that WWI cost something close to half of the US GDP.

At the end of the war all Allied Powers were cash strapped and heavily indebted to the US, to the point that it took a whole century for the debt to be repaid (Britain paid the final instalment of its wartime debt in 2014) albeit the savage inflation following the two wars made the nominal amounts tiny in the end.

This is one of the reasons why the Paris Conference of 1919 and the ensuing treaties saw formidable financial demands on the Central Powers and particularly Germany: everybody expected the Germans to pay for the untold damage they had caused both in aggression and in retreat (the French had, in addition to that, an old score to settle regarding the war “reparations” they had to pay the Second Reich for the 1870 lost war).

At the end of WWI the US was already a net creditor to nearly everybody.

Repeat the trick once again with WWII, and you have an established net creditor whose financial markets have learnt how to accommodate even extraordinary demands.

In the interwar years - in 1930 precisely - after long and bitter squabbles about who would pay whom (and with whose money, by the way), the US promoted the creation of the Bank for International Settlements (BIS) in order to act as a traffic warden on the settlement of import/export flows.

After the end of WWII the same scenario went on air again: all countries off the Gold Standard (again, after having suffered harshly to restore pre-war parities) and all cap in hand to try and manage their debt to the US.

Thanks to its position, the US became the world’ banker and clearing house in 1944 (Bretton Woods Agreement and the Gold Exchange Standard): the Dollar was thenceforth the only currency convertible in gold at a fixed parity, whilst all the others were fixed against the US Dollar.

Along with the Bretton Woods Agreement came the wold Bank (1944) and the International Monetary Fund (IMF, 1945).

The arrangement lasted until 1971, when the architecture created in Bretton Woods became untenable, but in the meantime, due to the position the US had carved for itself, with nearly all commodity trading being conducted in US Dollars due to its “umbrella” (or hub-and-spoke if you prefer) arrangement, it was natural to settle every trade in US Dollars.

It has remained so until toady, with both the World Bank and the IMF surviving the Bretton Woods Agreement, and with just a couple of hiccups: twenty minutes after a certain Saddam Hussein of Iraq mentioned the possibility of settling Iraq’s oil sales in Euros rather than Dollars he was no longer Iraq’s president/dictator (you name the title you prefer), and the same fate occurred to other unwise gentlemen.

As long as the US Dollar will retain its status as the world’s main reserve, commodity trade will tend to be conducted in Dollars, and trade being conducted in Dollars will make it less desirable to switch to other currencies for trading commodities. It is a self-sustaining feedback.

Thus said, with China’s economic might rising, it is not hard to imagine in a few decades a multipolar commodities market with the influence of the US Dollar waning.