| Updated: September 12, 2025Profile of the United States dollar – important facts
This lesson will cover the following
- Dominant currency in global transactions
- Other currencies pegged to the US dollar
- Interest-rate differentials between US government bonds and foreign bonds
Important facts regarding the United States dollar
First of all, over 90% of all currency transactions worldwide include the US dollar. Currency pairs such as EUR/USD, GBP/USD, USD/JPY and USD/CHF are the most liquid in the foreign exchange market and, consequently, traders prefer to trade them. All of them include the US dollar, underscoring how important it is to market participants. This also explains why economic, political and other events occurring in the United States trigger significant movements in most segments of the financial markets.
Second, before the events of 11 September 2001 the US dollar was regarded as one of the premier safe-haven currencies in the world. The reason was that the risk of major instability in the United States was considered very low. The country was viewed as having some of the most secure and developed markets worldwide. Because of the dollar’s safe-haven status, investments at discounted rates of return were pouring into the economy, and 76% of global currency reserves were held in US dollars. The dollar also plays an important role as the dominant factoring currency worldwide.
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Following 9/11, foreign investors, including central banks, reduced their holdings of US dollars because interest rates fell and uncertainty in the country increased. Moreover, the appearance of the euro was taken as a sign that the US dollar’s status as a premier reserve currency might be at risk. A number of central banks have already started diversifying their reserves by increasing their holdings of euros and reducing their dollar-denominated assets.
Third, a number of developing economies peg their domestic currencies to the US dollar. This arrangement requires their governments to maintain the dollar as a reserve currency while buying or selling their own currencies at the pegged rate. At the same time, governments are obliged to hold reserves of the foreign currency at least equal to the amount of domestic currency in circulation. Hong Kong and, until July 2005, China have pegged their currencies to the US dollar. Until 21 July 2005 China maintained a rate of 8.3 yuan per US dollar. After years of pressure to revalue its currency, China set the USD/CNY exchange rate at 8.11 and began adjusting the rate to the closing price each day.
Fourth, interest-rate differentials between US and foreign government bonds are closely watched by market participants. This relationship can signal potential movement in the foreign exchange market, as US financial markets are among the largest in the world and investors tend to react quickly to changes in the yields offered by US assets. As noted, large institutional investors seek higher-yielding assets. If yields in the United States fall or yields elsewhere rise, investors will be inclined to sell their US assets and buy foreign ones. Such a sell-off in US stocks and fixed-income assets would affect the foreign exchange market, as it would lead to selling of the US dollar and a relocation of funds to other currencies. Conversely, if US asset yields rise or foreign asset yields decrease, investors will be drawn to US markets and demand for the US dollar will increase accordingly.
Fifth, stock and bond markets influence US dollar trading. When stock markets are in an uptrend, foreign investment dollars tend to flow into the economy. If stock markets are plunging, domestic investors are likely to cut their holdings of local publicly traded companies and search for suitable opportunities elsewhere. In the fixed-income market, countries offering the highest yields will probably lure investors from abroad. Daily movements in both of these markets reflect shifts in foreign portfolio investment, and the latter is directly linked to transactions in the foreign exchange market.
In addition, significant mergers and acquisitions, especially those with a considerable cash component, will greatly influence currency markets because the acquiring company must buy or sell US dollars to finance its cross-border deal.