Why are global commodities traded in US dollars?

Q: Why are oil and gold and so many other commodities priced in U.S. dollars, regardless of where they come from? Is this an advantage or a disadvantage for U.S. investors?

A: The U.S. dollar is the world's trading and reserve currency of choice, and while that is a sign of strength, it also has its drawbacks.

Why is the dollar so dominant?

The U.S. has the world's largest economy, and while the U.S. has had its share of ups and downs, you would be hard-pressed to find a major economy that has had such consistent growth since World War II. The combination of size and stability makes a very compelling argument for using the dollar as, in effect, the international language of finance.

Is the dollar's popularity a blessing or curse?

You ask if that is good or bad for U.S. investors, and the answer depends on your perspective.

Being used so ubiquitously creates demand for the U.S. dollar, which helps support its value. That is good for U.S. consumers who pay less for imports than they would if the dollar were weak.

It is not so good for U.S. companies trying to compete with foreign companies whose cheaper currencies can give them a pricing advantage.

Similarly, the impact of the dollar's popularity on interest rates is a mixed blessing. Demand for the dollar and dollar-denominated securities helps keep U.S. interest rates low, despite the massive amount of debt racked up by the U.S. government (and individual consumers). You would appreciate the low interest rates if you had recently taken out a mortgage, but you would not be so wild about them if you have a lot of money in savings accounts earning practically nothing in interest.

It can also be argued that cheap borrowing is a form of hazard because it encourages the accumulation of large debts which might become unmanageable, especially if interest rates do eventually rise.

Overall though, most financial people would argue that being the world's trading currency is a positive: It lets investors focus on the supply-and-demand fundamentals of the commodities they are buying, rather than having to also account for currency as an unstable variable.

Will other currencies topple the dollar?

Of course, it is not a given that the dominance of the dollar will last forever. Various currencies have played a similar role in the past, and just as the dollar took over from the English pound in the last century, another currency might someday eclipse the dollar.

After all, there have been challengers. The euro was formed in part to create a multi-national currency with enough critical mass to rival the dollar. More recently, China's yuan currency has gained credibility as its economy has grown, and the country's plan to launch an energy futures exchange this year shows a clear intention to play a role as a trading currency. However, euro countries and now China will have to solve their own economic problems before their currencies are a serious threat to the dollar.

So, for better or worse, the dollar remains on the top of the heap.

Comment: Do you think the dollar will still stay on top in the future?

More from MoneyRates.com:

The blessing and burden of a strong dollar

What the weakening dollar means to you

What determines the strength of a currency?

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