Reserve Currency
Candlefocus EditorAside from foreign exchange reserves, central banks also hold a reserve currency portfolio as part of their reserves, which allows them to diversify their investments. The most recent example of this was seen with the Chinese renminbi being added to the International Monetary Fund’s Special Drawing Rights (SDR) basket in 2016. This basket is a combination of international reserve currencies and special drawing rights that countries can use to settle certain international payments.
The reserve currency also provides a stable means to value foreign currencies and track exchange rates. When markets are uncertain, central banks often turn to the reserve currency as a safe-haven investment that can protect against some of the risks that come with a fluctuating market. By diversifying their investments, central banks can more easily manage their capital and adjust to exchange rate fluctuations.
The use of the reserve currency for paying for international goods and services can offer countries a great deal of economic stability. A reserve currency provides a consistent source of liquidity which can be used to pay for imports and support domestic growth. Furthermore, a reserve currency can also act as a buffer against inflation, allowing countries to avoid devaluation of their local currency and remain competitive in global markets.
Reserve currencies also offer privileges to countries that utilize them. Since the reserve currency is often the accepted means of payment in international transactions, countries that possess it can exercise a great deal of economic power. Using a reserve currency can also reduce debt costs and promote foreign investment.
In conclusion, reserve currencies are integral in global trading, providing countries with an efficient means to move and settle international payments. A reserve currency also provides countries with a safe-haven asset to invest in, as well as stability and liquidity in foreign exchange markets. It is likely that the U.S. dollar will continue to remain the world’s reserve currency for the foreseeable future, though its share of global reserves may decline as other currencies become more widely accepted.