
What Is a Reserve Currency?
A reserve currency is a large quantity of currency maintained by central banks and other major financial institutions to prepare for investments, transactions, and international debt obligations, or to influence their domestic exchange rate. A large percentage of commodities, such as gold and oil, are priced in the reserve currency, causing other countries to hold this currency to pay for these goods. A reserve currency is a large amount of currency held by central banks and major financial institutions to use for international transactions. A reserve currency is a large quantity of currency maintained by central banks and other major financial institutions to prepare for investments, transactions, and international debt obligations, or to influence their domestic exchange rate. A large percentage of commodities, such as gold and oil, are priced in the reserve currency, causing other countries to hold this currency to pay for these goods. A reserve currency is a large amount of currency held by central banks and major financial institutions to use for international transactions. A reserve currency reduces exchange rate risk since there's no need for a country to exchange its currency for the reserve currency to do trade. 1:35 Holding a reserve currency minimizes exchange rate risk, as the purchasing nation will not have to exchange its currency for the current reserve currency to make the purchase. The foreign governments did not fully realize that although gold reserves backed their currency reserves, the United States could continue to print dollars that were backed by its debt held as U.S. Treasuries.

What Is a Reserve Currency?
A reserve currency is a large quantity of currency maintained by central banks and other major financial institutions to prepare for investments, transactions, and international debt obligations, or to influence their domestic exchange rate. A large percentage of commodities, such as gold and oil, are priced in the reserve currency, causing other countries to hold this currency to pay for these goods.




Understanding Reserve Currency
Holding a reserve currency minimizes exchange rate risk, as the purchasing nation will not have to exchange its currency for the current reserve currency to make the purchase. Since 1944, the U.S. dollar has been the primary reserve currency used by other countries. As a result, foreign nations closely monitor the monetary policy of the United States to ensure that the value of their reserves is not adversely affected by inflation or rising prices.
How the U.S. Dollar Became the World’s Reserve Currency
The post-war emergence of the U.S. as the dominant economic power had enormous implications for the global economy. At one time, U.S. Gross Domestic Product (GDP), which is a measure of the total output of a country, represented 50% of the world’s economic output.
As a result, it made sense that the U.S dollar would become the global currency reserve. In 1944, following the Bretton Woods Agreement, delegates from 44 nations formally agreed to adopt the U.S. dollar as an official reserve currency. Since then, other countries pegged their exchange rates to the dollar, which was convertible to gold at the time. Because the gold-backed dollar was relatively stable, it enabled other countries to stabilize their currencies.
In the beginning, the world benefited from a strong and stable dollar, and the United States prospered from the favorable exchange rate on its currency. The foreign governments did not fully realize that although gold reserves backed their currency reserves, the United States could continue to print dollars that were backed by its debt held as U.S. Treasuries. As the United States printed more money to finance its spending, the gold backing behind the dollars diminished. The increase monetary supply of dollars went beyond the backing of gold reserves, which reduced the value of the currency reserves held by foreign countries.
The Gold-to-Dollar Decoupling
As the United States continued to flood the markets with paper dollars to finance its escalating war in Vietnam and the Great Society programs, the world grew cautious and began to convert dollar reserves into gold. The run on gold was so extensive that President Nixon was compelled to step in and decouple the dollar from the gold standard, which gave way to the floating exchange rates that are in use today. Soon after, the value of gold tripled, and the dollar began its decades-long decline.
Continued Faith in the U.S. Dollar
The U.S. dollar remains the world’s currency reserve, due primarily to the fact that countries accumulated so much of it, and that it was still the most stable and liquid form of exchange. Backed by the safest of all paper assets, U.S. Treasuries, the dollar is still the most redeemable currency for facilitating world commerce. It for this reason that it's highly unlikely the U.S. dollar will experience a collapse any time soon.
The euro, introduced in 1999, is the second most commonly held reserve currency in the world. According to the International Monetary Fund (IMF), which is charged with promoting global growth and trade, central banks hold more than $6.7 trillion in dollar reserves versus 2.2 trillion in euros as of Q4 2019.
Related terms:
Bretton Woods Agreement & System
The Bretton Woods Agreement and System created a collective international currency exchange regime based on the U.S. dollar and gold. read more
Central Bank
A central bank conducts a nation's monetary policy and oversees its money supply. read more
Dollar Shortage
A dollar shortage develops when a country receives fewer U.S. dollars for goods it exports compared to the dollars it pays for imported goods. read more
Exchange Rate
An exchange rate is the value of a nation’s currency in terms of the currency of another nation or economic zone. read more
Foreign Exchange (Forex)
The foreign exchange (Forex) is the conversion of one currency into another currency. read more
Foreign Official Dollar Reserves (FRODOR)
Foreign official dollar reserves (FRODOR) is an indicator relating international liquidity to the effect of foreign central banks on U.S. monetary policy. read more
Gross Domestic Product (GDP)
Gross domestic product (GDP) is the monetary value of all finished goods and services made within a country during a specific period. read more
Great Society
Great Society refers to a set of government policy initiatives that were created in the 1960s; it was then-President Lyndon B. Johnson's answer to remedy issues of poverty and racism in the U.S. read more
International Monetary Fund (IMF)
The International Monetary Fund (IMF) is an international organization that promotes global financial stability, encourages international trade, and reduces poverty. read more