In this article, you will learn what reserve currencies are and why they are used for currency regulation, adjustment of the external payment balance, overcoming crises, etc.
What is a Reserve Currency?
The term “reserve currencies” refers to the national currencies of certain countries that have officially received this status. They are used by the central banks of other countries to create, accumulate, and store currency reserves.
Not every national currency can obtain the status of a reserve currency. Typically, for this to happen, the country’s economy must be stable and demonstrate efficiency. The balance of payments must be formed with minimal deficit, or at least effective measures must be taken to cover it. There must be minimal currency and trade restrictions, etc. In other words, the chances of becoming a reserve currency issuer are only for countries with the most developed economies.
This is confirmed by the current state of affairs: as of the end of 2022, according to IMF data, the following currencies had the status of reserve currencies:
- US dollar
- Euro
- British pound
- Japanese yen
- Yuan
- Swiss franc
- Canadian dollar
- Australian dollar.
Among them, the US dollar is the most widely used in the world.
Note! The IMF reports a record decrease in the role of the dollar’s share in global currency reserves. By the end of 2022, it reached a 27-year low. However, this did not displace the US currency from the top position.
The second most significant reserve currency, the euro, accounts for 20.47%. The third place is held by the Japanese yen with a share of 5.51%. Surprisingly to many, the share of the Chinese currency in global currency reserves has significantly increased. It accounts for 2.88%.
How Reserve Currencies Emerged?
The current global monetary system replaced the Bretton Woods system, in which the price of gold was fixed in US dollars, and the American currency was used for international settlements and reserve accumulation. The exchange rates of other currencies were kept stable within a narrow corridor.
After the dollar supply exceeded the US gold reserves, such a system could no longer function. In 1971, President R. Nixon abolished the dollar’s link to gold with his decision. This situation was accepted by other countries retrospectively at the International Conference in Jamaica in 1976. It was there that the current principles of the modern monetary system were agreed upon.
One of the main innovations was free pricing in the currency market. In fact, the exchange rate of national currencies was no longer set by authorities but determined by market trading results.
As early as 1944, the International Monetary Fund (IMF) was established, whose main task was to promote currency cooperation between countries. It operates within the framework of the Jamaica system. It is the IMF that is tasked with determining which currencies will be included in the composition of the basket of world reserve currencies, forming its own reserve asset – Special Drawing Rights (SDRs). It also approves the full list of global reserve currencies.
Note! Reserve currencies forming SDRs are considered primary, while those in the IMF’s list are considered secondary. Today, the basket of primary currencies includes the US dollar, euro, British pound, Japanese yen, and yuan.