A reserve currency is defined as a money that is used as a reliable means of international trade and economic stability. Governments and institutions around the world use reserve currencies as a stable legal tender to pay off international debts and influence exchange rates, as well as perform various other international trade functions. For many decades, since the end of WWII, the reserve currency most commonly used around the world has been the United States Dollar (USD). The following information elaborates on the usage of it, and also explains their necessity and how they're used globally.
What Are Reserve Currencies?
It is important to note that any money note that is stable and trusted can be used as a reserve currency, and the Euro and Yen follow closely behind the U.S. Dollar as the world's most popular. The basic concept of has existed in international trade for many centuries, however with the advent of the international banking system, the need for a such thing for all nation's has become exceedingly apparent. Many central banks hold (particularly the U.S. Dollar) in addition to their native currency primarily for strategic purposes such as economic redundancy in the case of contingency, or inflation of the local economy. Thus, although the U.S. Dollar is the main reserve currency, any legal tender that is used in the aforementioned nature to provide economic stability and international trading leverage could be deemed as one.
The United States Dollar as a Reserve Currency
Despite the recent decline and weakening of the dollar, it is still widely used as a reserve currency by about 70 percent of the world's nations. Thus, many of the global commodities used around the world such as gold, oil and other natural resources are generally priced in U.S. Dollars, which is another reason why the dollar is kept by many nations. At the end of World War II, the global financial system was restructured, with the United States Dollar at the center of the banking system. At that time the United States purchased gold from other nations, offering them the promise that their dollars could be traded for gold at a fixed rate at any time in the future. European nations, along with Japan, allowed their money to be somewhat devalued under this new system in exchange for being able to compete in global export industries. This original arrangement in which nations could trade U.S. Dollars for gold (known as the Bretton Woods System) was terminated in the 1970's by the government of the United States.
The Euro and Yen as Reserve Currencies
In recent years, the Euro has gained power and is becoming increasingly popular as a reserve currency, primarily due to the advent of the European Union and its economic influence on the nations of Europe, and subsequently the rest of the world. Because of this increased popularity, many speculate whether or not the Euro will eventually replace the United States Dollar as the world's most popular legal tender. The Japanese Yen is also gaining strength, and many banks are now switching their reserve currency from USD to EUR and YEN according to various news reporting agencies in 2009.
Although global economic stability remains uncertain and the Euro and Yen continue to gain on the United States Dollar, at the moment about two thirds of the world's nations currently store the U.S. Dollar, making it the 'world's reserve currency'.