Finance

Global Reserve Currency

The U.S. dollar is the current global reserve currency.  However, it hasn’t always been and it’s possible that something could replace it someday (perhaps sooner than later)…

Global Reserve Currency

The U.S. dollar is the current global reserve currency.  However, it hasn't always been and it's possible that something could replace it someday (perhaps sooner than later) and take away the crown its held since the mid-1900s.  But what is a global reserve currency and what does it mean for the United States that the dollar is our current one?

A Basic Explanation of Global Reserve Currency

A thrumming global economy functions on the back of one crucial component: the global reserve currency. With it, countries all over the world are able to conduct international trade for commodities as fundamental as oil and cotton without needing to conduct a complicated negotiation or simply not trading at all.  The definition is in the name.  "Currency", we all know what that is:  money.  So we're talking about something that can be used as money.  "Reserve" means that this currency is kept on hand in significant amounts to be used when needed.  Anything can be a "reserve currency", and chances are if you're a business that deals in foreign currencies for some reason, you probably have those currencies in reserve too.  "Global", though, is where the U.S. dollar, and any future global reserve currency, gets its power.  It's a worldwide reserve currency, meaning nations all over the world keep it in reserve because it's used as the basis of global trade.

Think about it like this:  if you're trading with multiple countries and they're all using their own currencies, then you'll have to constantly convert yours to theirs and vice versa.  This not only means a lot of complicated math, but it means instability in prices since foreign currency exchange rates can change drastically for a variety of reasons.  In order to maintain price stability and to make it easier on everyone, having a shared currency for conducting international trade would be best.  That's where a global reserve currency comes into play.

Because of the important role of the global reserve currency, countries must maintain a stockpile of the currency at all times to ensure that they’re able to trade for necessities in the event of a domestic crisis.  If their local currency goes into freefall, they'll still be able to buy $700 worth of groceries if they have $700 on hand.

In today’s world, the U.S. dollar is the major global reserve currency. That hasn’t always been the case, of course.  After all, the United States hasn't even been around that long, certainly not as long as we've had global trade. Prior to the dollar, there were five periods that saw other global reserve currencies - belonging to Portugal (1450–1530), Spain (1530–1640), Netherlands (1640–1720), France (1720–1815), and Great Britain (1815–1920).

Britain’s pound sterling lost the global reserve status in 1920 when the post-war boom it had been experiencing suddenly slowed and unemployment went into double digits, leaving the path open for the dollar to edge in.

The Dominance of the Dollar

While the pound sterling stumbled, the U.S. was engaged in the rapid acquisition of gold, having declared a gold standard at the turn of the century. Between 1900 and 1913, the U.S. doubled its supply of gold, nearly doubling it again by 1933.

At the same time, the U.S. was spearheading the Second Industrial Revolution, leading to the explosive development of factories that enabled mass production and new levels of widespread efficiency. It was enough for the dollar to displace the pound sterling as the world’s preferred reserve currency by 1920.

The U.S. continued to hoard gold throughout the booming 20s, though the stockpile became suddenly threatened with the Great Depression as millions of Americans rushed to trade in their dollars. As a result, the government - under President Franklin Roosevelt - forbade its citizens from owning gold in 1933.

The forced turn-ins of personal gold treasure troves drove the U.S.’s reserves to its highest point in history at 20,262 tonnes.

By the end of World War II, the U.S. was producing half the world’s GDP, along with possessing most of the world’s gold. The writing was on the wall, and, via the 1944 Bretton Woods agreement, the dollar officially became the global reserve currency.

Since then, despite the U.S. going off the gold standard in 1971 at the hand of President Nixon, there have been no viable challengers to the dollar’s dominance among the major reserve currencies of the world.

Reserve Currencies by share of total, chart
Source: CFR

That’s not to say that the dollar isn’t facing threats on the horizon, especially as the dollar has never been more vulnerable.

Future Contenders for a Global Reserve Currency

Time and again, media reports surface about the potential of de-dollarization - and while most are invariably dismissed as the dollar cruises through one period of economic unrest after another, there is some validity behind the concern.

Perhaps one of the most muscular contenders in the ring is BRICS, being an economic bloc led by Brazil, Russia, India, China, and South Africa that now comprises around 30% of the world’s GDP (or more than the U.S.-led G7).

Chart comparing BRICS vs G7 GDP over time
Source: Statista

While BRICS hasn’t made a clear plan or collective intention about creating a new currency that would be shared within its members and allies and potentially unseat the dollar as the global reserve currency, there has been talk of it.

The messages, however, are definitely mixed. India’s foreign minister said “there is no idea of a BRICS currency” in July 2023, dismissing the notion. A month later, Brazil’s president declared that BRICS should create a common currency.

If BRICS does make a group decision on creating a new currency in the same way the European Union developed the Euro, it’s in for a rocky road. Making a new currency requires a substantial amount of planning and preparation, notably switching over all domestic financial systems in each participating country to the new currency. In other words, if it happens, it will be a while until the BRICS currency is able to stand upright on the global stage but some kind of showdown between BRICS and the dollar does seem inevitable.

On the other hand, not every new currency requires substantial infrastructure replacement. Take cryptocurrency, for example. Bitcoin can be traded through a device as accessible as a mobile phone, making it easy for customers and vendors to conduct a transaction without any complicated international exchange rates to factor in.

Bitcoin has another advantage in the fact that it is decentralized by its nature. Unlike the dollar, which is directly tied to the fortunes of one country and one central bank, bitcoin is not privy to local or regional catastrophes or economic instability. And unlike central bank currencies, there are no possible risks of sudden inflation due to the Fed ordering the printing of more units.

For a cryptocurrency like bitcoin to become the global reserve currency, it will need to demonstrate its stability and become widely accepted among the nations of the world - not all of whom have opened their doors to the digital currency. It may be on the path toward global acceptance, but it’s got a ways to go yet.

In the meantime, the U.S. dollar continues its dominance, even if it is a shaky one.  Fortunately, gold is still an important currency around the world and is particularly important as a safe haven, not just for individual investors but for entire nations, including the U.S.  Even if the U.S. dollar does falter, the country has a huge store of gold that will hopefully help it limp through the tough times and come out on the other side.

Global Reserve Currency FAQs

What is a global reserve currency?

A global reserve currency is the currency that most nations conduct international trade with.  This means they will hold that currency "in reserve" for the purpose of international trade.  The U.S. dollar is currently the global reserve currency.

What currencies have been global reserve currencies in the past?

A truly global reserve currency is a modern conception since in the early days of human history, global trade was not possible.  Still, nations traded with each other in what would be the "known world" for them.  In Ancient Times the Greek drachma and the Roman denari were used as reserve currencies, along with currencies of other nations as political and international dynamics shifted.  The Venetian ducat and Florentine florin were early reserve currencies traded in the region until the Spanish silver dollar became the first true global reserve currency.  The Spanish silver dollar was eventually replaced by the British pound sterling, which the U.S. dollar eventually displaced following World War II.

Are there other reserve currencies besides the U.S. dollar?

Yes.  Nations tend to hold different foreign currencies for a variety of reasons.  Some may hold currency as an investment in the other nation's currency or as a hedge for stability against their own currency.  For example, if the value of a nation's currency plummets, their foreign currency reserves would still likely hold their original value.  Countries may also hold currency of nations they tend to trade with regularly, sometimes forgoing using dollars for some transactions.  The top reserve currencies after the U.S. dollar are the Euro and the Japanese yen.

What happens if the U.S. dollar is no longer the global reserve currency?

While nobody can predict the future, it is probably safe to say that the U.S. dollar losing its global reserve currency status would be bad news for the United States and many Americans.  The value of the dollar, which is already on the decline, would likely plummet as much of its current value is tied to its demand in international trade.  There would also be large political ramifications, and while the U.S. would remain a superpower (largely thanks to its military and nuclear arsenal), it would certainly lose a lot of power and influence on the world stage.  Depending on which currency fills the void, other countries may find themselves with a lot more pull in international politics.

What could replace the U.S. dollar as the world's global reserve currency?

There has been an effort around the world to "de-dollarize" and move away from reliance on the U.S. dollar.  This movement has been gaining steam lately, particularly as the value of the U.S. dollar has been on the decline and countries who aren't very friendly with the U.S. have grown in economic power (such as Russia and China).  However, the U.S. dollar is still far far ahead of any other foreign currency as a reserve currency.  This doesn't mean the dollar's position is safe, though.  Global reserve currencies have been replaced in the past, and the U.S. dollar is perhaps at its most vulnerable.  Leading candidates to replace the U.S. dollar as the global reserve currency are the Chinese yuan, a joint BRICs currency and Bitcoin (or another cryptocurrency).

Is gold a global reserve currency?

In a way, gold is a global reserve currency, but not the global reserve currency.  Gold and silver both hold intrinsic value and have a long history of being used as currency, backing currency and in international trade.  As such, many nations do hold gold as a reserve asset.  Generally today nations do not conduct trade using gold and prefer rather to hoard it (truly keeping it in reserve).  In this way gold may have lost some of its economic utility, but it proves its lasting purpose as a store of value.  So while gold isn't used as regularly as the U.S. dollar or other currencies in trade, wealthy nations still try to keep as much of it on hand as possible to safeguard their economic future.

Can Bitcoin be a global reserve currency?

In theory, yes, Bitcoin could be a global reserve currency.  Its independence from any single nation makes it a good, impartial candidate for a global reserve currency, but global reserve currencies require consensus from nations around the world (at least the top ones who can bully the rest of the world into following suit), and it's unlikely the U.S. and its allies would willingly hand over that role to Bitcoin or another cryptocurrency (except for one they create, maybe).  However, several world governments do own considerable amounts of Bitcoin and other cryptocurrencies, such as El Salvador which is estimated to hold nearly 3,000 Bitcoin.  The U.S. may be the largest government holder of Bitcoin, though, as it has seized around 400,000 Bitcoin.  About half of that has been sold off, and the rest is planned to be.

Can there be more than one global reserve currency?

There probably cannot be more than one global reserve currency.  By definition, a global reserve currency is "global" and would need to be the basic method of conducting international trade throughout the world.  In theory there could be more than one, though.  However, it would be more complicated having multiple global reserve currencies and countries would need to split their reserves in half (or more) to accommodate.  Still, countries today do keep a variety of reserve currencies on hand, but the amount tends to pale in comparison to how much they hold in U.S. dollars, the current global reserve currency.  Specific reserve currencies are selected based on local needs and preferences, while a global reserve currency is a worldwide standard.  It's unlikely to get nations to agree on allowing other currencies to join the U.S. dollar and even with multiple global reserve currencies, one would likely come out on top as the preferred global reserve currency.  So it would most likely only be a transitional step.

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