Understanding Reserv: Definition and Implications
Reserve currency definition
A reserve currency is used globally by countries and corporations to borrow funds, as a store of wealth and to carry out international transactions like buying commodities. For example almost all oil is priced in dollars, globally.
The US Dollar is the world’s largest reserve currency. Reserve currencies are used globally by countries and corporations to borrow funds (debt), as a store of wealth and to carry out international transactions. The world’s top reserve currencies in 2019 is the US Dollar, Euro, Japanese Yen, Pound sterling and the Chinese Renminbi. The reserve currencies ordered by the amount of foreign reserves held by central banks globally are presented below:
- U.S. Dollar: 61.8% ($6.74 trillion)
- Euro: 20.2% ($2.21 trillion)
- Japanese Yen: 5.3% ($572 billion)
- British Pound: 4.5% ($495 billion)
- Chinese Renminbi: 1.95% ($213 billion)
Reserve currency countries
The main advantage of economies with reserve currency status is their ability to borrow (issue debt) on their own currency. This is because capital markets consider these economies low risk and have confidence in their economic systems, their policymakers, and their political systems. Countries with reserve currency status, however, must be really careful with their monetary policy and fiscal policies since prolonged money printing (debt monetization) may destroy the capital markets’ confidence for the specific currency as a store of value. This historically this has often lead to capital flows towards alternative currencies such as gold.
The US Dollar history
The US Dollar became the world’s reserve currency since the creation of the Bretton Woods system in 1944.