Reserve Currency
A reserve currency is a currency that central banks hold in large amounts as part of their foreign exchange reserves and that is widely used to price trade, issue debt and settle international payments. The US dollar is the dominant one.
Also called: reserve currencies · global reserve currency · world reserve currency · anchor currency
A currency earns reserve status through use, not by declaration. It needs deep and open financial markets, a large supply of safe assets such as government bonds, legal predictability and few restrictions on movement. The dollar accounts for a little under 60 percent of disclosed global reserves, the euro about a fifth, with the yen, sterling, renminbi and others making up the rest.
Reserve status feeds on itself. Commodities are priced in dollars, so importers need dollars; banks lend in dollars, so borrowers need dollars to repay; and most currency pairs trade through the dollar. This is why so many cross-border payments between two non-US countries still clear through US correspondent banks, and why US sanctions and regulation reach so far.
The issuer gains cheaper borrowing and influence. It also takes on exposure: foreign demand for its currency is outside its control, as the offshore Eurodollar market shows.
Commonly confused with
| Term | How it differs |
|---|---|
| Special Drawing Right | Inclusion in the SDR basket recognises a currency as freely usable. It does not by itself make central banks hold it or markets trade in it. |
See also
- Foreign Exchange ReservesForeign exchange reserves are the foreign-currency assets a central bank holds and can use at short notice: deposits and government securities in major currencies, gold, Special Drawing Rights and the country's reserve position at the IMF.
- Hard CurrencyA hard currency is one that is widely accepted for international payment, freely convertible and expected to hold its value, such as the US dollar, euro, yen, pound sterling or Swiss franc. Suppliers abroad generally insist on being paid in one.
- Special Drawing RightThe Special Drawing Right (SDR) is an international reserve asset created by the IMF. It is not a currency and cannot be spent directly; it is a claim that a member country can exchange for US dollars, euros, yen, sterling or renminbi.
- EurodollarA Eurodollar is a US dollar deposit held at a bank outside the United States, or at an offshore unit of a US bank. Eurodollars are created by bank lending abroad and sit largely beyond US banking regulation; they have nothing to do with the euro.
- Bretton Woods SystemThe Bretton Woods system was the international monetary order agreed in 1944, under which currencies were fixed to the US dollar and the dollar was convertible into gold at US$35 an ounce. It created the IMF and the World Bank and ended in 1971.
- Correspondent BankingCorrespondent banking is an arrangement in which one bank holds deposits for another bank and makes and receives payments on its behalf, normally so the second bank can reach a currency or a market where it has no branch or license of its own.