A reserve currency is one that is held in large numbers by a foreign country’s central bank or monetary authority.
Reserve currencies are held for a number of reasons including:
- To minimise exchange rate risks
- To sure up the domestic currency
- To make complex international payments between countries
- To help, support and facilitate global trade
Throughout history, from the early modern period, there have been eras in which one or two currencies were dominant.
In the 1500s it was the coins of the Spanish and Portuguese Empires. In the 1600s it was the Dutch currency. From the 18th to the mid-20th centuries it was the French Franc and the Pound Sterling.
Today the largest reserve currency by far is the USD, however, many other currencies are also held in reserves in significant proportions. We’ll look at the top 5 five reserve currencies below.
US Dollar: 58.81%
Unsurprisingly in 2022, the US Dollar is the world’s most powerful currency. Something you’d expect given the super-power status of the country. Over 58% of all currency held in reserve is USD.
USD took its place as the dominant reserve currency in the 1950s following the Bretton Woods Agreement, the end of WW2, the beginning of the Cold War and the decline of the United Kingdom’s economic power. Until this point, Sterling was king.
After the war, the dollar became the currency of world trade as US exports spread across the planet. Its rise was fuelled by consumer goods from now household names like Ford, General Electric, Kellogg’s and Coca-Cola.
By the early 1980s, the US was unrivalled in economic power, massively overtaking its closest rival the USSR in economic clout. USD was, therefore, able to dominate the 80s, the 90s and 00s.
However, its position as the primary reserve currency is for the first time in a long time slowly starting to be challenged. The US is no longer the world’s dominant exporter and the US as a whole is no longer seen as the strong, stable colossus it once was. China has already overtaken the US in GDP as measured by PPP and is set to overtake in real terms in the coming years.
Whilst the Dollar currently remains the world’s dominant currency, there’s no doubt that the Renminbi is snapping at its heels, looking one day to unseat what many people call ‘King Dollar.’
Given the combined economic power of the Eurozone countries, it’s unsurprising that their currency is one of the world’s most significant reserves.
The Euro’s strength as a reserve currency goes back many years despite as a currency, being one of the world’s newest at just 20 years old.
The Euro inherited the power of one of its predecessor currencies, the Deutsche Mark.
The Deutsche Mark was one of the world’s most powerful currencies at the time. Growing in significance throughout the 70s and accounting for at one point nearly 20% of global reserves in 1990.
For many years, commentators speculated that the Euro could become the world’s major reserve currency however the 2011 Eurozone Crisis put a dent in this.
The Euro of today is no longer seen as being as stable as previously thought, particularly as anti-EU/Euro sentiment has risen rather than declined in recent years across the bloc
Japanese Yen: 5.57%
Like Germany, Japan emerged from the chaos of the Second World War like a phoenix rising from the ashes.
Over the second half of the 20 century, the Japanese economy shifted towards high-tech production and became an economic giant.
Its consumer goods were exported around the globe. You only need to think about brands like Toyota, Hitachi, Sony, Mitsubishi and Panasonic to see how the Japanese economy and therefore its currency, the Yen, became a popular reserve currency.
Japan is well known for its domestic political stability and non-radical politics and therefore is a relative safe haven and a good solid currency to hold in reserve.
Pound Sterling: 4.78%
For many years, Sterling was THE currency of international trade and thus the world’s most significant reserve currency.
Running an empire on which the sun literally never set, encompassing 25% of the entire global population, from the early 1800s to the Second World War, the UK was easily able to dominate the world’s economy
It held for over 50 years a position similar to that of the current day US Dollar. (At one point, 80% of all world currency reserves were in GBP).
Sterling though hit a decline following the end of the Second World War.
Despite being victorious, the cost of the war decimated the UK economy and hastened the collapse of the Empire. In 1944, the Bretton Woods agreement amongst the allies created a new global financial system with the US dollar at its centre. This marked the end of the Sterling dominance and the decline in the amount of GBP being held in reserves.
Despite being eclipsed by the US Dollar, GBP is still used as a reserve in a small way, around 5% of all reserves at any one time are held in sterling. This is in part due to London being one of the world’s most significant financial centres.
Renminbi (Chinese Yuan): 2.79%
If the US and Britain dominated the 20th century, the 21st century will be dominated by China.
The economic powerhouse of 1.4 billion people has a booming economy and a currency that is growing in significance.
The total world reserves of the Renminbi now sit at around 3% and have doubled in the last couple of years alone.
Given China is projected to overtake the US as the world’s largest economy in the near future, commentators are now speculating if/and when the Yuan will follow historical precedent and become the world’s dominant reserve currency.