Reserve Currency

A reserve currency is the one at the centre of international transactions and central bank foreign reserves. The US dollar currently holds that position.

Certain conditions are required: a large economy, deep financial markets, political stability, and the ability to convert into other assets at any time. Trust is the core of it.

The issuing country enjoys substantial advantages. It can borrow in its own currency, and because the world wants that currency, it borrows cheaply — sometimes called an exorbitant privilege.

Other countries feel the consequences. When the United States raises rates, money leaves emerging markets and their currencies weaken. The shock arrives regardless of their own economic condition.

Reserve currencies have changed historically, passing from the Dutch guilder to the British pound and then to the dollar. Such transitions typically take decades. What matters to an individual is that holding some dollar assets reduces currency risk. When a local currency weakens in a crisis, dollar assets rise in local terms and cushion the blow.