In addition to accounting for the majority of global reserves, the dollar remains the currency of choice for international trade. Major commodities such as oil are primarily bought and sold using U.S. dollars, and some major economies, including Saudi Arabia, still peg their currencies to the dollar. As of July 2023, China has by far the most reported foreign currency reserves of any country, with more than $3 trillion. India, Russia, Saudi Arabia, Switzerland, and Taiwan also have large reserve holdings.
A reserve currency is a foreign currency that is held in significant quantities by central banks or other monetary authorities as part of their foreign exchange reserves. The reserve currency can be used in international transactions, international investments and all aspects of the global economy. In such a global economy, where countries ship commodities and goods at such a frenetic pace, the fear of markets seizing up due to monetary constraints is not likely to diminish in the coming years. The recent financial crisis has increased the pressure on the dollar, especially in light of public debt prospects and political brinksmanship.
When a country acquires reserves, it doesn’t place the currency in general circulation. The reserves are acquired through trade, with the acquiring country selling goods in exchange for currency. The euro is the second most used reserve currency, accounting for roughly 20 percent of global foreign exchange reserves. The European https://www.forex-world.net/ Union rivals the United States in economic size, exports more, and boasts a strong central bank and robust financial markets—factors that make its currency a viable challenger to the dollar. But the lack of a common treasury and a unified European bond market limits its attractiveness as a reserve currency, according to Setser.
Major reserve currencies
Critics of a dollar-dominated currency market have pointed out that it may be increasingly difficult for the U.S. to keep up with world dollar demand as its weight in the global economy shrinks. Rather than use the dollar, central banks have looked towards using a basket of currencies, called special drawing rights. This protocol would effectively reduce the influence of any one country and ostensibly would force more prudent economic policies.
“Both the United States and the world at large would benefit from a less dominant U.S. dollar,” writes Michael Pettis, a professor of finance at Peking University. China has been trying to boost the global role of the renminbi, also known as the yuan, since the late 2000s. It currently accounts for 3 percent of global reserves, but China has increasingly pushed to use the renminbi in bilateral trade, especially in the wake of the Ukraine war. However, Chinese policymakers are wary of the lessons from previous currencies [PDF] that rapidly internationalized, and they have imposed strict controls on the flow of money that have hamstrung the renminbi’s growth. “China does not have the intention or the capacity to dethrone the dollar,” says CFR’s Zongyuan Zoe Liu. For years, leaders of BRICS countries have discussed a framework for a shared currency, with proponents arguing that it would protect against devaluation when the dollar rises.
- The popularity of reserve currencies is a function of their stability and reputation.
- Many countries still manage their exchange rates either by allowing them to fluctuate only within a certain range or by pegging the value of their currency to another, such as the dollar.
- Some have proposed the use of the International Monetary Fund’s (IMF) special drawing rights (SDRs) as a reserve.
- The dollar, while still the most widely held reserve currency, has seen increased competition from the euro.
- China’s renminbi was named by the IMF as a global reserve currency in 2015.
In the first half of the 20th century, multiple currencies did share the status as primary reserve currencies. Although the British Sterling was the largest currency, both the French franc and the German mark shared large portions of the market until the First World War, after which the mark was replaced by the dollar. The popularity of reserve currencies is a function of their stability and reputation. For example, the Chinese yuan hasn’t taken off as a major reserve currency due to concerns over a sudden devaluation that could send their value lower. The same is true for the euro following the sovereign debt crisis in 2009 and the immigration crisis in 2016 and 2017. These issues have led to concerns over currency volatility, which has kept the U.S. dollar as the most popular reserve currency through the early twenty-first century.
Japanese yen
In 2022, global central banks held over half of their reserves in U.S. dollars. China has positioned its currency as next in line to the U.S. dollar; it has been the largest contributor to world growth since 2008’s global financial crisis. China’s renminbi was named by the IMF as a global reserve currency in 2015. However, the euro still accounts for the largest portion of currency reserves after the U.S. dollar due to the economic size of the European Union. The economic upheaval caused by the pandemic and the war in Ukraine has renewed concerns about the downfall of the dollar as the leading reserve currency.
As of 2022, central banks held around 59% of their reserves in U.S. dollars, according to the International Monetary Fund (IMF). The U.S. dollar was officially crowned the world’s reserve currency and backed by the world’s largest gold reserves thanks to the Bretton Woods https://www.investorynews.com/ Agreement. Instead of gold reserves, other countries accumulated reserves of U.S. dollars. Treasury securities, which they considered to be a safe store of money. Many of them are specifically designated as reserve currencies by the International Monetary Fund (IMF).
“There’s no doubt that if the dollar were not so widely used, the reach of sanctions would be reduced,” says Setser. By buying and selling currencies on the open market, a central bank can influence the value of its country’s currency, which can provide stability and maintain investor confidence. For instance, if the value of the Brazilian real starts to fall during an economic downturn, the Central Bank of Brazil can step in and use its foreign reserves to bid up its value.
The majority of developed countries pegged their currencies to gold as a way to stabilize currency exchanges. When World War I broke out in 1914, many countries suspended the gold standard to pay their military expenses with paper money, which devalued their currencies. Britain held to the gold standard to maintain its position as the world’s leading currency and found itself borrowing money for the first time during the third year of the war. Today, the U.S. dollar isn’t the only reserve currency designated by the IMF and other global organizations.
The Dollar: The World’s Reserve Currency
The dollar’s status as the global reserve currency was cemented in the aftermath of World War II by the 1944 Bretton Woods Conference, in which forty-four countries agreed to the creation of the IMF and the World Bank. Countries also keep an eye on major reserve currencies to ensure that their holdings aren’t adversely affected. For instance, strong inflation in the U.S. could cause a devaluation of the U.S. dollar. In the end, this limits the monetary policy benefits that are achievable using these reserves. It creates only a marginal benefit for a country’s currency if it is considered a reserve currency around the world. Instead the euro’s stability and future existence was put into doubt, and its share of global reserves was cut to 19% by year-end 2015 (vs 66% for the USD).
John Maynard Keynes proposed the bancor, a supranational currency to be used as unit of account in international trade, as reserve currency under the Bretton Woods Conference of 1945. Delegates from 44 Allied countries met in Bretton Wood, New Hampshire, in 1944 to develop a system to manage foreign exchange that would not disadvantage any country. The delegation decided that the world’s currencies would no longer be linked to gold but pegged to the U.S. dollar. They also can defend a national currency and even determine sovereign credit ratings. Treasury Secretary Janet Yellen, say that the aggressive use of sanctions could threaten the dollar’s hegemony. “Sanctions are an effective tool, but we have to be careful,” CFR’s Benn Steil told NPR.
The argument is that, in the absence of sufficiently large shocks, a currency that dominates the marketplace will not lose much ground to challengers. Because other countries want to hold a currency in reserve and use it for transactions, the higher demand means lower borrowing costs through depressed bond yields (most reserves are of government bonds). Issuing countries are also able to borrow in their home currencies and are less worried about propping up their currencies to avoid default. The dollar was first printed in 1914, a year after the establishment of the Federal Reserve as the U.S. central bank with the passing of the Federal Reserve Act.
Drawbacks of Reserve Currency Status
Reserve currencies can also be foreign currency securities, deposits, and loans. Because Canada’s primary foreign-trade relationship is with the United States, Canadian consumers, economists, and many businesses primarily define and value the Canadian dollar in terms of the United States dollar. Thus, by observing how the Canadian dollar floats in terms of the US dollar, foreign-exchange economists can indirectly observe internal behaviours and patterns in the US economy that could not be seen by direct observation. Also, because it is considered a petrodollar, the Canadian dollar has only fully evolved into a global reserve currency since the 1970s, when it was floated against all other world currencies. In 1973, President Nixon’s New Economic Policy brought an end to the Bretton Woods system of fixed exchange rates. It also decoupled the U.S. dollar from the value of gold, which opened up the world to the rise of new reserve currencies.
It is the most commonly held reserve currency and the most widely used currency for international trade and other transactions around the world. The centrality of the dollar to the global economy confers some benefits https://www.dowjonesanalysis.com/ to the United States, including borrowing money abroad more easily and extending the reach of U.S. financial sanctions. The euro, introduced in 1999, is the second most commonly held reserve currency in the world.
