Since the end of World War II, the dollar has been the underpinning of the world’s economy. It is commonly referred to as the world’s reserve currency.
By the end of WWII, the United States was one of the few major developed countries that was undamaged by war. Other WWII participants had to repair years of significant war damage while getting their peacetime economies going again. The United States was in a position to lend other countries money to help them recover, and that made the US currency, the dollar, critical to most or all of the rest of the world.
In a 1944 meeting at Bretton Woods, New Hampshire, 44 countries agreed to guarantee that their currencies would be convertible to the US dollar, letting the dollar be the peg, or centerpiece, for a worldwide monetary system. The Bretton Woods participants still had fresh memories of the problems that happened after the end of WWI, when war reparations resulted in hyperinflation in Germany, which in turn ultimately led to the start of WWII. The Bretton Woods agreement was intended to create a stable, world-wide, post-war monetary system with a systematic plan for recovery and repair from the war.
The Bretton Woods agreement, and the massive amount of lending of US dollars to other countries to pay for their recoveries, led to the dispersion of the US dollar around the world. Other countries needed to acquire US dollars so they could repay their dollar-based loans, and that meant that they had to sell things for dollars and accumulate dollars in their central banks.
Over time, US dollars became a universal form of money, and many transactions outside the US were settled in US dollars without ever involving a US bank or anyone in the US. Economists use the term Eurodollar to describe this. Although it sounds like it applies to US dollars used in Europe, the term actually is used to describe any US dollars held outside the USA.
Another reason the dollar is so prevalent is explained by another economic term, the petrodollar. Since at least the 1970s, oil has been priced and settled in US dollars. Countries that produced a lot of oil, like the OPEC countries, accumulated huge stockpiles of US dollars they received in payment for their oil, and they then spent those dollars elsewhere. Countries that needed to buy oil had to accumulate US dollars so they could buy oil. SInce every country is either a buyer or a seller of oil, US dollars have been widely distributed around the world.
For anyone outside the US, everything priced in US dollars has two prices, the price in dollars, and the price in their local currency. To buy oil, countries in Europe have to convert their local currency to US dollars first, then purchase the oil in dollars. The number of dollars they get for their currency is constantly changing, depending on the exchange rate. Their cost of that purchase will be the cost in US dollars plus or minus their gain or loss on the conversion of their currency. For instance, it is possible that the dollar cost could be dropping but the exchange rate loss could be increasing, making the oil more expensive than it was previously in Europe while the price is less expensive than before in the US. US companies do business in lots of other countries, and the money they earn in those countries has to be converted to dollars, and that conversion could increase or reduce the value of those foreign sales. Exchange rates add a confusing wrinkle to the raw price in dollars.
When the dollar is expensive relative to other currencies, it is called a strong dollar. When the dollar strengthens, it means that each dollar can buy more units of foreign currencies. This makes imported goods cheaper for US consumers, since they can buy the same amount of imported products for fewer dollars. A stronger dollar makes US exported products more expensive for foreign buyers because the same product now costs more in their currency.
When the dollar is cheap compared to other currencies, it is called a weak dollar. A weaker dollar makes imports more expensive for US consumers since each dollar buys fewer units of foreign currencies, so the same amount of goods costs more in dollars. A weaker dollar makes US exports cheaper for foreign buyers because the same product now costs less in their currency,
The dollar typically becomes stronger when inflation is low and the US economy is in good shape. Higher US interest rates tend to strengthen the dollar since others want to invest here. The dollar tends to be weaker when inflation is high, the economy is sagging, or if there is any question about the country's ability to pay its debt, like when the national debt is high. All of the considerations of what makes the dollar strong or weak are relative to what's going on in other countries. If other countries are in worse shape, the dollar will be stronger. If other countries are doing better, the dollar will be weaker. Another thing that could potentially weaken the dollar would be if it was no longer as widely used around the world.
An interesting development in Argentina is a newly-elected President, Javier Milei, who intends to dollarize the country by make the dollar the official currency of Argentina. The Argentinian peso is extremely weak right now because Argentina has been experiencing hyper-inflation, which was 143% a year leading up to the election. The goal of dollarization would be to stabilize prices by tying them to the much more stable US dollar.
On the other hand, there are other world events that may weaken the dollar. Monetary sanctions were applied to Russia when Russia invaded Ukraine, the goal was to make it difficult or impossible for Russia to use US dollars. Some experts are now concerned that punishing Russia with monetary sanctions encourages more countries to reduce their dependence on the dollar. One unsurprising result of the sanctions is that Russia is working hard to de-dollarize. They are selling oil to China and other countries for Chinese yuan instead of dollars, and are working with several countries to develop an alternate global currency system called BRICS (based on the names of the countries that started the effort, Brazil, Russia, India, China, and South Africa).
It’s unlikely that anything will replace the dollar as the world reserve currency in the short term, it would take years for any other currency to supplant the importance of the dollar. But new currencies like BRICS and efforts to price oil in other currrencies could lead to big changes in the role of the US dollar in the long term.