Currency Reserve: Overview, History, Examples

A currency reserve is a currency that is held in large amounts by governments and other institutions as part of their foreign exchange reserves. These reserve currencies usually become the international pricing mechanisms for commodities traded on the global market such as oil, natural gas, gold, and silver, causing other countries to hold this currency to pay for these goods. Currently, the U.S. dollar is the primary reserve currency in the world, kept not only by American banks but by other countries.

Key Takeaways

• Currency reserves are currencies held by another country’s central bank for purposes of promoting stability for the underlying economies and providing a unified basis for international money exchange.
• Central banks usually pick stable currencies, such as the U.S. dollar, the most common reserve currency in the world. The euro is the second most common.
• Besides holding foreign currencies, central banks also hold gold and the International Monetary Fund’s special drawing rights (SDR), which are both recognized internationally as universal exchange assets.

Understanding Currency Reserves

Reserves act as a shock absorber against factors that can negatively affect a currency’s exchange rate, so a nation’s central bank uses its currency reserves to help maintain a steady rate, buying or selling depending on which direction they want exchange prices to go.

Manipulating and adjusting the reserve levels can enable a central bank to prevent volatile fluctuations in currency by affecting the exchange rate and increasing the demand for and value of the country’s currency.

Periodically, the board of governors of a central bank meets and decides on the reserve requirements as a part of monetary policy. The amount that a bank is required to hold in reserve fluctuates depending on the state of the economy and what the governing board determines as the optimal level.

Important

The U.S. dollar is the most commonly-held currency reserve, accounting for 58% of the $11.5 billion of the allocated reserves as of Q2 2024.

Examples of Reserve Currencies

In the past, reserve currencies have come about in a de facto manner: They simply were the currency that belonged to the most powerful nations or the ones that dominated trade. The Bretton Woods Agreement (see below) essentially appointed the U.S. dollar as the world’s leading currency reserve in 1944. But there are other popular currencies held in reserves.

The closest thing to an official list of reserve currencies comes from the International Monetary Fund (IMF), whose special drawing rights (SDR) basket determines currencies that countries can receive as part of IMF loans.

The euro, introduced in 1999, is the second most commonly held reserve currency. Others in the basket include the Japanese yen and the British pound sterling. The latest addition, introduced in October 2016, is China’s yuan or renminbi.

Note

Countries like Germany and China—which have the largest trade surpluses—also have the most currency reserves because they receive U.S. dollars and other foreign currencies when they provide exports.

The U.S. Currency Reserve System

In the U.S., almost all banks are part of the Federal Reserve System and it is required that a certain percentage of their assets be deposited with their regional Federal Reserve Bank.

These reserve requirements are established by the Fed’s Board of Governors. By varying the requirements, the Fed can influence the money supply. Reserves also keep the banks secure by reducing the risk that they will default by ensuring that they maintain a minimum amount of physical funds in their reserves. This increases investor confidence and stabilizes the economy.

The Dollar As the World’s Reserve Currency

In 1944, during World War II, 44 nations met and decided to link their currencies to the U.S. dollar, the U.S. being the strongest power among the Allies.

As a result of the Bretton Woods Agreement, the U.S. dollar was officially crowned the world’s reserve currency, backed by the world’s largest gold reserves. Instead of keeping supplies of gold, other countries accumulated reserves of U.S. dollars; central banks would maintain fixed exchange rates between their currencies and the greenback.

After the war ended, the restructured governments of the former Axis powers also agreed to use dollars for their currency reserves.

The U.S. dollar went off the gold standard in the 1970s, leading to contemporary floating exchange rates. But it remains the world’s reserve currency, and the most redeemable currency for global commerce and transactions, based largely on the size and strength of the U.S. economy and the dominance of the U.S. financial markets.

Which Country Has the Highest Reserve Money?

China held the most foreign exchange reserves at $3.7 trillion as of September 2024. Japan held the next most reserves at $1.3 trillion. The United States held $45 billion in reserves.

What Is the Current Reserve Currency?

Many currencies can serve as a reserve currency, however, the U.S. dollar is considered the world’s reserve currency. This has to do with a multitude of factors, such as the U.S.’s dominance after World War II and the strength of its economy; the largest in the world. Other factors that contributed and continue to contribute to this are the U.S.’s political and military power, its facilitation of international trade after World War II, and countries often wanting to trade in dollars due to its safety and stability.

What Is the Meaning of a Reserve Currency?

A reserve currency is a foreign currency held in a nation’s central bank and used for international trade and other purposes. For example, Japan holding U.S. dollars would be the U.S. dollar as a reserve currency for Japan. This allows Japan to facilitate certain global transactions by using its U.S. dollars, such as the buying and selling of oil, which is done in USD. Countries also hold reserves to hedge against exchange rate risk in order to maintain financial stability.

The Bottom Line

Currency reserves are meant to stabilize economies and manage global exchange rates. Central banks hold them in order to facilitate international trade and support monetary policy. The U.S. dollar is by far the world’s most used reserve currency. The U.S. dollar wields such power due to the economic strength of the country. Other reserve currencies include the euro, yen, and pound.