Reserve Currency
A currency held in large quantities by central banks and used in international trade and debt contracts.
What is Reserve Currency?
A reserve currency is a foreign currency held in significant quantities by central banks and major financial institutions as part of their foreign exchange reserves. Reserve currencies are used to settle international trade, denominate commodities like oil, and service sovereign debt. The US dollar has been the dominant global reserve currency since the Bretton Woods agreement in 1944, accounting for approximately 60% of global foreign exchange reserves. A country whose currency is the reserve currency benefits from the "exorbitant privilege" of borrowing at lower rates and running trade deficits without immediate currency crises. Other significant reserve currencies include the euro, Japanese yen, British pound, and Chinese renminbi.
Example
When Saudi Arabia prices oil in US dollars, oil-importing nations must hold dollars to pay for energy. This structural demand keeps the dollar strong even when US fundamentals would not support its value. The IMF's Special Drawing Rights (SDR) basket tracks the major reserve currencies: the dollar (about 44%), euro (31%), Chinese renminbi (11%), yen (8%), and pound (8%) as of 2022.
Source: IMF — Currency Composition of Official Foreign Exchange Reserves