The US Dollar really needs no introductions. It is the international heavyweight among currencies, the world's foremost reserve and legal tender of the largest economy and military power on earth.

Commonly referred to as the greenback or buck, the Dollar is used by 10 countries and territories and is pegged by 22 countries throughout South America, the Caribbean and the Middle East.

Economics

The US Dollar has dominated global currency markets since the US first emerged as a superpower following WW2. With Britain and European nations heavily indebted and economically weak, the Bretton-Woods agreement set the scene for the Dollar to become the world's reserve currency.

Despite having surrendered some ground with the emergence of the Euro, the strength of the Dollar remains undisputed internationally and the Dollar serves as a magnet for investors across the globe. As the default currency for the purchase of oil and gold, the world's two most valuable commodities, the Dollar benefits from a safe haven status in addition to its value as a reserve. When risk aversion and economic uncertainty plague markets and investors flock to tangible assets the Dollar, along with the Yen and Swiss Franc, are the major beneficiaries. This allows the US government to run large budget and trade deficits whilst retaining its core strength and the Dollar to remain stable, even thrive, amidst financial turmoil.

Influences

In terms of influences on the Dollar, its central status in the global economy means it really is a law unto itself. Whilst affected by global events; commodity prices, OPEC decisions, equity markets and domestic conditions, often the ground the Dollar loses in confidence it will make up for in safe haven status. This ensures the currency is insulated against major declines in the global economy.

That said, the recent credit crisis has been the most major challenge to the health of the Dollar since the Great Depression and is worth a brief digression to illustrate the centrality of the US Dollar to the global economy.

Global Credit Crisis

The origins of the current financial crisis are widely attributed to the sub-prime mortgage market in the US. Since the collapse of this market, a series of shocks and aftershocks have been felt throughout the world and fundamentally altered the financial landscape.

Source: www.newsvote.bbc.co.uk

Following a decade of booming economic growth in the US, high market confidence, disposable income and easy credit created a burgeoning sub-prime mortgage market in which risky debts were offered to people with poor credit histories on a huge scale. However, during the 2 years between 2004 and 2006 interest rates rose rapidly, from 1% to 5.35%, forcing many of these sub-prime lenders to default on repayments. Although by that stage, the complex nature of debt re-packaging and fluidity of international credit markets meant that the 'toxic' debts had spread throughout the financial system.

In April 2007 New Century Financial, a company which specialises in sub-prime mortgages, filed for bankruptcy. Having on-sold debts to banks and other financial institutions, the collapse in the sub-prime market begins to take effect for US banks. By July, Bear Stearns had to warn customers the money they invested may not be safe.

Under normal conditions banks survive by lending heavily to one another. The Bear Stearns scenario essentially froze interbank lending as banks refused to lend in favour of shoring up liquidity for themselves. Central Banks including the Federal Reserve, ECB, Bank of Canada and Bank of Japan lent large amounts to banks in an attempt to improve market liquidity.

By September 2007, the crisis had spread around the world and Northern Rock in the UK experienced its biggest 'run on the bank' in more than a century. By the end of 2007, the world's strongest economies faced a major downturn as the lack of available credit brought with it economic uncertainty, low market confidence, unemployment and repossessions.

Panic Mode

Throughout 2008, as a consequence of the bad debts in the sub-prime market, major banks were forced into billion dollar write downs. International governments persisted with billion dollar bail outs of lending giants such as Northern Rock in the UK and the Federal mortgage guarantors Freddie Mac and Fannie Mae in the US but in the absence of interbank lending to provide much needed liquidity, there was nowhere for banks to go but down.

On the 15 September 2008, CEO Richard Fuld declared Lehman Brothers, the fourth largest securities firm in the US bankrupt, triggering a wave of panic selling which wiped billions from equity markets internationally. Interbank lending froze once again and central banks made billions available in overnight loans to prevent full scale collapse of credit markets. Even the practice of short-selling, usually a legitimate market activity, was banned as markets were deemed so volatile the effects could be potentially devastating. Panic and fear characterised markets as nervous investors speculated on who would be the next to fall. Risk aversion and investor flight to tangible assets such as oil and gold buffered the US Dollar against the worst of the crisis, but shares in Wall Street were hit heavily.

Source: www.newsvote.bbc.co.uk

In the aftermath of Lehman's Central Banks, led by the Federal Reserve, announced unprecedented handouts to underwrite interbank lending and buy preferential shares while flooding markets with capital to improve wafer thin liquidity. A series of partial nationalisations of major banks occurred throughout the US, UK and Europe, with the irony of the failed free-market ideology escaping no one. The US government made $700 billion available in the rescue package, with £250 billion pounds in the UK.

Source: www.newsvote.bbc.co.uk

Just days after the rescue packages were announced, 6 central banks announced a co-ordinated interest rate cut of 50 basis points in an attempt to breathe life into the ailing global economy. Markets responded well, posting enormous rallies, yet have persisted with bearish trends as the data in recent weeks indicates recession is likely to persist into the second quarter of 2009. The MSCI World Index of global equities has declined 41% thus far in 2008.

Future

Despite being at the epicentre of the downturn, the US Dollar has emerged relatively unscathed from the crisis due to its unique and inherent strength as the world's reserve and a safe haven currency.

As risk aversion favours tangible assets and strong stable currencies, the Dollar has also benefited from its status as the default tender for the purchase of oil and gold, commodities that are unlikely to fall out of favour anytime soon. In addition, the repatriation of foreign investment is further supporting the Dollar, at the expense of countries on the periphery of the global economy. This week, Hungary has secured a $21 billion loan for IMF assistance and the Federal Reserve has pledged $120 billion dollars to South Korea, Mexico, Brazil and Singapore.

Quarter 3 GDP is released for US this week and is likely to show the country in recession as a result of the sub-prime crisis. Yet while the Dollar was quick to fall in the early stages of the credit crunch, the very structure of the international system is designed to ensure the place of the Dollar as a superpower.