A world currency does not exist. However, reserve currencies are used by central banks, corporations, and governments for international transactions. Since World War II, the dominant global reserve currency has been the U.S. dollar. Emerging market economies often have debt denominated in U.S. dollars instead of local currency.
Key Takeaways
- There is no world currency, but reserve currencies are used in transactions by central banks, corporations, and governments.
- The U.S. dollar is the world’s most widely used reserve currency.
- About 60% of the central bank currency reserves are held in dollars, and many commodities are priced in dollars.
USD and the Gold Standard
All currencies were once backed by gold, meaning that every country had to hold enough gold in reserve for the currency in circulation. England was the first country to adopt a gold standard in 1819.
After World War II, Western powers developed the Bretton Woods Agreement, the framework for the global currency markets until 1971. Within the Bretton Woods system, all national currencies were valued at the U.S. dollar, which became the dominant reserve currency.
Due to the global expansion after the war, bank reserves did not hold enough gold to back the domestic currency to finance expansion. Consequently, the U.S. disconnected from the gold standard and began to print more paper money to finance the world’s growth requirements. Because the U.S. was a strong economy, other countries agreed to accept the dollar as tender and followed suit.
De Facto World Currency
About 60% of the central bank currency reserves are held in U.S. dollars. Central banks hold reserves to facilitate trade and financial transactions. About 90% of the world’s foreign exchange transactions are in dollars. Many commodities are priced in dollars since the dollar provides a stable medium of exchange between international companies. Dollar-denominated commodities include:
Important
The euro, the common currency of many European member states, is the second most widely-held currency and comprises approximately 20% of global reserves.
Other Reserve Currencies
While the U.S. dollar remains the dominant reserve currency, the world can be divided into three main currency blocks, with the Americas dealing mostly in dollars, Europe dealing in euros, and the Asian countries mostly connected to the yen. In 2024, two other major reserve currencies are the euro and the Japanese yen (JPY).
A cross-currency is when a currency pair or transaction does not involve the U.S. dollar, such as Australia with Japan using AUD/JPY. A floating exchange rate is where the currency price of a nation is set by the forex market based on supply and demand relative to other currencies.
When countries can intervene to buy or sell their currency to minimize value fluctuations, it is deemed a “managed floating exchange rate.” Australia, Canada, Japan, and the United States have this type of exchange rate.
What Are Forex Transactions?
Forex transactions occur when currencies are converted or exchanged into other currencies through investing, global trade such as exports and imports as well as financial transactions from corporations.
What Prohibits the Chinese Yuan From Becoming a Major Reserve Currency?
There are obstacles to the yuan becoming a major reserve currency. China has capital controls that prevent Chinese investors from transferring their yuan out of the country. Conversely, the yen, euro, and dollar are freely traded with no restrictions.
What Are the Most Commonly Traded Currency Pairs?
A currency pair includes a base currency and a quote currency. The base currency is the currency shown on the left. The quote currency is the currency on the right. In 2024, the most traded pairs include EUR/USD (euro/U.S. dollar), USD/JPY (U.S. dollar/Japanese yen), and GBP/USD (British pound/U.S. dollar).
The Bottom Line
Although the U.S. dollar is the world’s most widely used reserve currency, there is no distinct world currency. Approximately 60% of global central bank currency reserves are held in U.S. dollars. The euro and Japanese yen are also considered major reserve currencies.
