Comment by lackstein

The challenge is that for a lot of countries, the forex markets for their own currency aren’t deep enough to settle all of their international trade.

Consider a country that has a large trade imbalance—they import a lot of goods and have very few exports. When a business in that country tries to import goods, say from the Philippines in Pesos or from Germany in Euros, the business will have to go to a forex markets and sell their local currency to buy the foreign currency.

Who’s going to take the other side of that trade? Normally, if a country exports a lot of goods, then foreign businesses will need to buy the country’s local currency to pay for them, and that provides a market for exchanging Pesos and Euros for the local currency. But the country doesn’t export very much, so other businesses in the Philippines or the Eurozone don’t have much use for the business’ local currency, and that means that there isn’t a large market of people selling Pesos or Euros to buy the local currency.

This example is a bit of an edge case where this fictional country runs a trade deficit with all of its trading partners. In reality, you’ll likely have a trade deficit with some partners and a surplus with others. If you decide to denominate some of your international trade in US Dollars, then you’re able to use the excess dollars coming in to your country from your exports to finance your imports. It’s a lot easier than hoping that you can sell enough of your local currency or the currencies of the countries you’re exporting to to buy enough of the currencies of the countries you’re importing from.

In some ways it’s similar to the hub-and-spoke model of airlines. If you want to get from small town A to small town B, there might not be enough traffic in both directions to warrant a direct flight. But if there’s a hub X, then there might be enough traffic between A and all the other flights into X to make it worthwhile to fly from X to B and vice versa. There might not be enough balanced trade between two small countries for there to be a deep market in their currency pair, but if you have both imports and exports denominated in US Dollars then you can generate an internal market in your country for exchanging your local currency for USD.