The U.S. dollar is crucial for Americans and global markets alike, and its international standing affects investments, borrowing costs and everyday prices.
One of the dollar’s influential international roles is as the dominant reserve currency. What is a reserve currency? We answer that question and others about the dollar’s status.
What is a reserve currency? Is it the same as an international currency?
International currencies are widely used between countries for the exchange of goods, services and assets. The U.S. dollar (USD) is the most widely used, employed in 89% of foreign exchange transactions in 2025, while the euro is in second place, in 29% of foreign exchange transactions, according to data in the Bank for International Settlements (BIS) Triennial Central Bank Survey. (Because there are two currencies per foreign exchange transaction, the percentages add up to more than 100.)
A reserve currency is one that is widely used in international foreign exchange reserves, which are balances of safe, liquid assets that governments and/or central banks keep on hand for several reasons, including:
- Exchange rate management
- Insurance against sudden loss of ability to pay for imports caused by a halt to capital inflows, such as foreign direct investment in the domestic economy, foreign purchases of domestic stocks and bonds, or domestic borrowing from the rest of the world
- Insurance for other economic contingencies such as wars or natural disasters
Liquid assets are those that can be sold easily. Safe assets are those whose value is unlikely to be substantially reduced by issuer default, inflation or the imposition of capital controls, which legally restrict international capital flows, such as asset purchases, sales or lending. In other words, foreign exchange reserves are rainy day funds for governments.
Globally, the five largest holders of foreign exchange reserves in 2024 were China, Japan, Switzerland, India and Russia. As of 2024, China alone held 26% of all foreign exchange reserves around the globe, while Japan followed with 9%, according to data in the International Monetary Fund (IMF) International Reserves and Foreign Currency Liquidity dataset.
Why is the U.S. dollar a world reserve currency?
The USD has been the dominant reserve currency since 1945, with dollar-denominated securities, mostly U.S. Treasuries and investment-grade corporate bonds, making up approximately 57% of global foreign exchange reserves, for a value of $7.4 trillion, according to another IMF dataset, Currency Composition of Official Foreign Exchange Reserves (COFER), as of the third quarter of 2025. Euro-denominated securities are in second place, making up approximately 20% of global foreign exchange reserves.
Governments and central banks hold large quantities of U.S. dollar assets because the U.S. government and corporations issue a large amount of dollar-denominated, liquid assets that are seen as safe. In other words, international investors see the U.S. government and corporations as very unlikely to default on the bonds either explicitly or through unexpected inflation or through the passage of laws restricting international payments of Treasury bond coupons and principal.
To earn such a reputation for its assets, the U.S. has had solid legal and economic institutions and an open and generally well-regulated financial system. All these factors reduce the perceived risk of investing in such assets.
When did the U.S. dollar become a world reserve currency?
Before World War II, countries generally had limited foreign exchange reserves. Most developed countries tried to return to the gold standard after World War I ended in 1918 but then left it during the Great Depression of the 1930s. During that time, governments typically held a combination of gold and the British pound to serve the role of foreign exchange reserves.
After WWII, the U.S. was the dominant global economy, producing about 40% of world output in 1960, according to the World Bank Group’s World Development Indicators. A combination of factors caused countries to choose to hold dollar assets as foreign exchange reserves. The most important was probably the Bretton Woods system of fixed exchange rates, which was created in 1944.
Under this system, countries fixed their currencies to the U.S. dollar—promising to buy and sell foreign exchange to maintain the fixed price—and the U.S. obligation was to fix the price of the dollar to gold at $35 per ounce. To defend their exchange rate pegs against potential speculative attack, foreign countries accumulated liquid U.S. dollar assets as reserves. Some of these dollars entered foreign holdings from U.S. aid while others were obtained by exporting goods and services to the U.S.
Besides the U.S. dollar, what currencies are widely used as reserve currencies?
The USD is the dominant reserve currency, with dollar-denominated securities composing approximately 57% of global foreign exchange reserves as of the third quarter of 2025, according to the COFER dataset.
The other major reserve currencies are the euro, the Japanese yen, the British pound, the Canadian dollar and the Chinese renminbi.
According to COFER data, in recent years the euro has accounted for about 20% of reserves, the yen for about 6%, the pound for about 5%, and the Canadian dollar and renminbi for about 3% and 2% each.
If the value of a reserve currency declines, does it affect its status as a reserve currency?
Changes or expected changes in foreign exchange rates could affect the proportion of dollars held in foreign exchange portfolios in two ways.
First, from an accounting point of view, the change in a currency’s proportion of a foreign exchange portfolio depends on the change in the relative value of that currency.
Let’s look at a simple example. Suppose that the initial dollar-to-euro exchange rate is 1, so $1 buys one euro. Also suppose that a country has a foreign exchange reserve portfolio consisting of 1 billion dollars and 1 billion euros. At the initial 1:1 exchange rate, that portfolio is worth $2 billion, and U.S. dollar assets make up 50% of that portfolio.
Suppose now that the dollar declines in value by 10% against the euro, so it now requires 1.1 dollars to buy a euro. The portfolio’s dollar value is still $1 billion, but the value of the 1 billion euros has risen in dollar terms to $1.1 billion because each euro is now worth 1.1 dollars. The total value of the portfolio is now $2.1 billion, and the proportion of dollar assets is $1 billion to $2.1 billion, or 47.6%.
So, changes in the dollar’s value mechanically affect the proportion of foreign exchange portfolios it makes up, and this is true whether you measure the portfolio’s value in dollars or in another currency.
Second, while governments and central banks are unlikely to make portfolio decisions based on past changes in the dollar’s value, they might very well reduce their dollar holdings if they expect the dollar to decline in value in the future or if its value were highly volatile. Complicating this story, however, is that financial markets are forward looking, so general expectations of bad U.S. economic policy or excess volatility would translate rather quickly into immediate declines in the dollar. In other words, if markets come to expect the dollar to fall a lot next week, the resulting selloff will make it decline immediately instead. This is an implication of the efficient-market hypothesis, for which Eugene Fama won a Nobel prize in economics in 2013.
The short story is that if markets or market participations, such as governments or central banks, come to believe that the U.S. will engage in bad U.S. economic policy that endangers the value of the dollar, they might seek to rebalance their portfolios as soon as they can, which would drive down the value of the dollar.
While we wouldn’t rule out that it happens sometimes, we don’t know of evidence that governments and central banks do much speculative rebalancing of their foreign exchange portfolios.
Notes
- Germany, Japan and the United Kingdom left the gold standard in 1931; Canada left gradually from 1931 to 1933; the U.S. left in 1933; and France and Italy left in 1936.
- As of 2024, the U.S. produced about 25.9% of world output in nominal terms, or about 14.6% after adjustment for relative price levels, according to World Bank Group data.
