The term “reserve currency” is used when we refer to the common use of the any currency, for e.g.US dollars, by other countries to settle their international trades. For example, if India buys oil from Iran, it may pay Iran in US dollars rather than rupees, and vice versa. However, the basic reason for creation of “reserve currency” no longer exists, and today some currencies are called as “reserve currencies” just because they are hold in large quantities by many countries as matter of ongoing convention.
British pound sterling is considered as the first reserve currency because many countries favored holding pounds more convenient compared to gold during the age of hold standards.
The Bretton Woods Agreement
United Nations Monetary and Financial Conference, which was held in Bretton Woods, United States, convoked 730 delegates from all the 44 Allied nations, to set the global financial and economical in order after the World War II. During this agreement, the US dollar was given the status of “reserve currency”. Though the Fed committed not to inflate the dollar and to exchange it for gold at $35 per ounce, still the Fed back tracked and abrogated the “gold standards” in 1971.
The banking community selects the prime reserve currency for the strength and stability of the issuing economy. Thus, if an economy becomes less dominant, banks might abandon it for a currency that is considered stable. Though this a long process and in the coming future, anything could happen – even bitcoins !
Special drawing rights
SDRs are calculated daily from a basket of U.S. dollar, euro, Japanese yen and British pounds, for international payments. Some countries propose to use SDRs as the reserves, as they opine that it could help to stabilise the global financial system.
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