Despite struggles with its value, the U.S. dollar remains the key international currency, Standard & Poor’s Ratings Services argues in a report today.

“Notwithstanding the recent depreciation of the dollar against most of the European currencies, the U.S. dollar holds a leading position in foreign exchange trading, in share of international reserves and international trade, according to data compiled by the Bank for International Settlements, the International Monetary Fund, and the Federal Reserve Bank of New York,” said Standard & Poor’s credit analyst Nikola Swann, in a news release.

“Without the dollar’s status, the U.S. would not have such ready access to external financing; interest rates would have to rise to attract higher domestic savings; growth would slow well below potential. The U.S. dollar did not attain this position by accident, however, nor is it simply maintained by inertia,” added Swann.

That strength derives from the size of the economy, the flexibility of labour and product markets, and — relative to other large developed nations — the prospect for higher productivity growth and favorable investment returns over the medium term, S&P said.

The report notes, however, that the U.S.’s external position is weak. Net external debt relative to current account receipts is among the highest of rated sovereigns. In 2006, 44% of U.S. federal government debt held by the public was owned by foreigners, and this share has increased steadily since 2001, when it amounted to 30%. Of the federal government’s external debt, foreign central banks hold two-thirds.

“To motivate external creditors to maintain their holdings of U.S. dollars, U.S. policymakers are ever more pressured to pursue strong macroeconomic policies, particularly in light of the gradual-but-consistent depreciation vis-à-vis the dollar’s chief competitor, the euro, since 2005. Any policy that exacerbates the imbalances would put the dollar’s role as the key international currency more at risk,” Swann said.

The greatest uncertainty is the trajectory of the U.S. fiscal deficit, Standard & Poor’s notes. The rating agency expects the general government deficit as a share of GDP to fall below 2.5% this year and to remain at or below this level through 2009, but it notes that the dollar could come under increased pressure if the U.S. fiscal accounts deteriorate or if investors come to doubt the government’s willingness to address the fiscal challenges that loom in the next decade. Lesser risks emanate from rising inflation or protectionist trade policies.

“Fiscal outturns, inflation figures, trade volumes, and foreign exchange volatility will be the leading indicators should the dollar’s role begin to diminish. In the medium term, such a worst-case scenario would even weigh on the ‘AAA’ rating on the U.S.,” Swann said.