Demystifying the economy | The power of reserve currency

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Delphine Belzile
The Press

First, a reserve currency is a “desired currency in international transactions.” Countries will want to acquire it and hold it in the event of instability in the monetary system,” explains David Dupuis, professor of economics at the University of Sherbrooke and former economist at the Bank of Canada.

For example, a country whose currency is no longer recognized on the international market could be able to repay its debts with its reserves of American dollars. In other words, the reserve currency ensures financial stability, underlines David Dupuis.

In Argentina, the central bank recently put inflation at 90%. Tuesday, the New York Times asserted that “the US dollar is king in Argentina due to the collapse of the Argentine peso, particularly in recent months”. The population, which no longer has confidence in its local currency, keeps US dollars in reserve to ensure financial stability, explains David Dupuis.

We also talk about the US dollar as a reserve currency since foreign countries use it as an asset in their financial balance sheet, specifies the specialist. Since there is no financial gain to be had by holding a currency, countries tend to convert it into US government bonds to benefit from interest rates.

The main world currency

According to David Dupuis, the American dollar is the principal world currency for two reasons, one historical, the other economic.

After World War II, the international community abandoned the dominant monetary system, the gold standard, in favor of a currency regime. The new monetary order ensured a fixed exchange rate: the American dollar was connected to gold, and foreign currencies to the American dollar, explains David Dupuis. The greenback then became a global currency.

Under the Nixon government, Americans disassociated themselves from gold, and currencies began to fluctuate. However, since the country has the “biggest, most liquid and deepest financial market across the country”, everyone wants to hold the US dollar to this day, points out David Dupuis.

There are advantages to being the issuer of a global currency: strong demand for the US dollar keeps the value of the currency high. Thus, for the United States, “everything costs less on the market”, explains David Dupuis. It simplifies transactions on the international market.

In addition to the US dollar, central banks have an interest in keeping yuan, euros and pounds sterling as reserve currencies to facilitate international payments.