Why is the US dollar the world's reserve currency? What is its relationship with the Federal Reserve?

好的，咱们来聊聊这个话题。这事儿说复杂也复杂，说简单也简单，我尽量用大白话给你讲清楚。

Why has the US dollar become the world's reserve currency?

You can imagine all the currencies in the world as students in a classroom, and the US dollar is like the class monitor who's been in charge for decades. Everyone trusts him, they turn to him for anything, and they're all willing to carry around his "little notes" (dollars) in their pockets. Why did he get to be the class monitor? There are several main reasons:

1. Historical Reasons: Strong Foundation, Early Start

Emerging in the Spotlight after WWII: After World War II, Europe and Asia were largely in ruins. Only the US mainland remained largely unaffected; in fact, it made a fortune selling weapons and accumulated most of the world's gold.
The Bretton Woods System: In 1944, a conference was held in a place called Bretton Woods in the US to discuss the post-war economy. The final decision was to peg the US dollar to gold ($35 = 1 ounce of gold), and other national currencies would then be pegged to the dollar. This was like the US patting its chest and telling the world, "Don't worry, folks, my dollars are backed by shining gold, absolutely reliable!" From that moment on, the dollar officially took its seat as the "class monitor." Although this system dissolved in the 1970s, the habit of using dollars had already been established.

2. Economic Strength: Abundant Resources, Large Market

The US is the world's largest economy and its largest consumer market. Countries worldwide want to sell their goods to the US to make money. What's the most convenient currency for business transactions? Naturally, it's the buyer's (US) currency. Over time, international commodity trading, such as oil, iron ore, and soybeans, has largely been priced and settled in US dollars.

The Petrodollar System: This was crucial. In the 1970s, the US reached an agreement with Saudi Arabia and other major oil-exporting countries, stipulating that oil transactions must be settled in US dollars. Think about it: which country doesn't need oil for its development? Since buying oil requires US dollars, every country has to reserve some dollars, otherwise, they wouldn't even be able to buy oil when it's critically needed. This created a continuous "loyal demand" for the dollar.

3. Financial Market: Stable Standing, Good Liquidity

The US financial market, especially its Treasury market, is the largest, most mature, and deepest in the world. What does this mean?

Safety: It's generally believed that the US government won't default on its debts, so buying US Treasury bonds is considered one of the lowest-risk investments. Central banks worldwide hold hundreds of billions or even trillions in foreign exchange reserves; they need a safe place to put them, right? Buying US Treasury bonds becomes the top choice.
Convenience (Good Liquidity): If you want to buy hundreds of billions of dollars in US Treasury bonds, you can do so anytime; if you want to sell, you can offload them anytime, without your transaction causing drastic price fluctuations. It's like a massive, 24-hour supermarket with abundant stock and free buying and selling. Other countries' financial markets are too small to accommodate such large capital inflows and outflows.

4. Habit and Inertia: Everyone Uses It, So Do I

This is like how we all use QWERTY keyboards for typing now; it might not be the most efficient design, but because everyone is used to it, and computers, phones, and typing tutorials are all based on this standard, trying to switch to a new one would be too costly. Global banking systems and trade settlement systems have already built vast infrastructures around the dollar. Replacing it would be a monumental undertaking, affecting everything, and extremely difficult.

How is this connected to the Federal Reserve?

If the dollar is the "class monitor," then the Federal Reserve (the Fed) is the "brain" and "steward" of that class monitor. Its relationship with the dollar's status is incredibly close; one could say they are mutually reinforcing.

1. Guardian of Credibility

The reason the dollar is globally trusted is largely because people believe the Fed has the ability and willingness to maintain the stability of the dollar's value. One of the Fed's primary tasks is to control inflation in the US. If the Fed were to recklessly print money, causing the dollar to depreciate daily, who would want to hold onto a handful of constantly shrinking paper?

You can think of it this way: People are willing to deposit money in a bank because they trust it is well-managed and won't fail. The world is willing to reserve dollars also because they trust the Fed, the manager of this "dollar bank," to be professional and reliable. The Fed's independence and credibility are the cornerstones of dollar hegemony.

2. The 'Master Valve' of Global Liquidity

The Fed controls the amount of dollars in the market and the cost of borrowing through monetary policies such as adjusting interest rates (raising or lowering) and quantitative easing (QE). Because the dollar is a world currency, every decision made by the Fed impacts not just the US economy, but the entire world.

When the Fed raises interest rates: This means the interest on depositing dollars becomes higher, making the dollar more "valuable." Global capital will then rush into the US, converting into dollar assets. This can lead to capital outflow from other countries, their currencies depreciating, and even trigger economic crises.
When the Fed cuts interest rates/prints money: This means there are more dollars in circulation, and the cost of borrowing decreases. These extra dollars flow worldwide, investing in various countries' stock and real estate markets, potentially fueling asset bubbles.

In short, when the Fed turns the "faucet," the whole world feels the "water temperature." This powerful influence, in turn, reinforces the dollar's central position.

3. The 'Lender of Last Resort' in Times of Crisis

During global financial crises (like in 2008), the world faces a dollar shortage because, amidst panic, everyone wants to hold the safest asset – dollar cash. At such times, the Fed steps in, providing significant dollar liquidity to other major central banks through "currency swaps" and other means, preventing the global financial system from collapsing.

No other central bank in any other country can play this role. When everyone is in a panic, the Fed is the institution that can print what everyone wants most (dollars). This "savior" role undoubtedly greatly strengthens the dollar's and the Fed's core position in the global financial system.

To summarize:

The dollar became the world's reserve currency thanks to a combination of historical opportunities, powerful economic and military strength, and a deep and open financial market.

And the Federal Reserve, as the issuing and managing authority of the dollar, its credibility and policies are crucial for maintaining this status. It's like the "captain" of the dollar's vast ship; every one of its decisions not only determines the ship's direction but also stirs the entire global financial ocean.

Therefore, the dollar's status and the Fed's policies are like two sides of the same coin, jointly shaping the global financial landscape we see today.