Reserve currency
Based on Wikipedia: Reserve currency
Every empire that ever dominated world trade has left behind a curious artifact: its money. Long after the legions have marched home and the trading ships have rotted in harbor, the coins keep circulating. The Greek drachma outlived Alexander. The Roman denarius survived the fall of Rome. And today, roughly sixty percent of all the foreign currency held by governments around the world consists of United States dollars—even as economists wonder how long that can possibly last.
This is the story of reserve currencies: the money that other countries trust enough to stockpile.
What Makes a Currency "Reserve"
At its core, a reserve currency is simply foreign money that governments and central banks keep in their vaults. But that simple definition obscures something profound about how the global economy actually works.
When Thailand wants to buy oil from Saudi Arabia, the transaction doesn't happen in Thai baht or Saudi riyals. It happens in dollars. When Argentina needs to repay loans to European banks, those loans are denominated in dollars or euros. When nervous investors flee a financial crisis, they don't convert their wealth into the local currency of whatever country happens to be stable—they buy dollars, or perhaps Swiss francs, or Japanese yen.
This creates an enormous advantage for the country whose currency everyone else wants to hold. The United States can buy goods from around the world at relatively low prices, because everyone already needs dollars to conduct their own international trade. More importantly, when the whole world wants to lend you money in your own currency, you can borrow cheaply. The interest rates the United States pays on its debt are lower than they would otherwise be, precisely because dollar-denominated assets are in such high demand.
Economists call this the "exorbitant privilege." The phrase was coined, somewhat bitterly, by a French finance minister in the 1960s.
A Tour Through Monetary History
The dollar's dominance feels permanent, but history suggests otherwise. Reserve currencies come and go, usually following the rise and fall of the great powers that issue them.
The story begins, in a sense, with silver and gold. In the thirteenth century, European and Arab merchants conducting long-distance trade faced a problem: whose coins could they trust? The answer turned out to be the Venetian ducat and the Florentine florin—gold coins minted to exacting standards by Italian city-states whose bankers had earned a reputation for reliability. Gold was preferable to silver for this purpose because it was easier to mint in consistent sizes and lighter to transport across the Mediterranean.
But the real first global reserve currency was Spanish. When conquistadors discovered the silver mines of Mexico and Peru, they unleashed a flood of precious metal onto world markets. The Spanish silver dollar—the famous "piece of eight" that pirates coveted in fiction and reality alike—became the currency of choice from Manila to Massachusetts. For three centuries, from roughly 1500 to 1800, Spanish silver was the closest thing the world had to a universal money.
The Dutch tried to compete. The Bank of Amsterdam, founded in 1609, pioneered practices that would later become standard central banking: maintaining stable exchange rates, providing reliable clearing services, and backing deposits with actual reserves. But the Dutch guilder never achieved the reach of Spanish silver. The Netherlands was simply too small, and its colonial empire, while impressive, couldn't match the sheer output of Spanish American mines.
Sterling's Century
The British pound's rise to dominance coincided with the Industrial Revolution and the expansion of the British Empire. By the late nineteenth century, Britain had become the workshop of the world, the leading exporter of manufactured goods, and the center of global finance. London's insurance markets, commodity exchanges, and banks attracted capital from everywhere. Over sixty percent of world trade was invoiced in pounds sterling.
This happened partly because of economics and partly because of monetary policy. Britain committed to the gold standard—the promise that anyone holding pounds could exchange them for gold at a fixed rate. This gave international merchants confidence that the pound would hold its value. Other countries followed suit, and for a brief period before World War One, the major economies of the world operated on what historians now call the "classical gold standard."
It was, in retrospect, a remarkably stable system. It was also completely dependent on Britain's economic dominance and political stability.
The First World War shattered both.
The American Century Begins
Britain nearly bankrupted itself fighting Germany. The British government borrowed heavily, sold off foreign investments, and eventually abandoned the gold standard in 1931 after speculators attacked the pound. By then, the United States had already surpassed Britain as the world's largest economy—though it took several more decades for the dollar to fully displace sterling as the world's leading reserve currency.
The transition was formalized in 1944, at a conference in Bretton Woods, New Hampshire. With Europe in ruins and the war still raging, representatives from forty-four Allied nations gathered to design a new international monetary system. The result placed the dollar at the center of everything.
Under the Bretton Woods system, the United States promised that foreign central banks could exchange their dollars for gold at thirty-five dollars per ounce. Other currencies would peg their values to the dollar. This meant that indirectly, the whole world was still on a gold standard—but the anchor of the system was American gold reserves and American economic might.
The system worked beautifully for about twenty years.
The Triffin Dilemma
In 1960, a Belgian-American economist named Robert Triffin identified a fundamental problem with the Bretton Woods arrangement. His insight was so important that it now bears his name: the Triffin dilemma.
Here's the problem. For the global economy to grow, other countries need more dollars to conduct international trade. The only way for them to get those dollars is for the United States to run trade deficits—buying more from the rest of the world than it sells. But if the United States runs persistent deficits, eventually foreign countries will accumulate so many dollars that they'll start to doubt whether America actually has enough gold to back them all.
In other words, the reserve currency country faces an impossible choice. If it maintains a balanced trade position, the world runs short of the money it needs to conduct trade. If it runs the deficits necessary to supply the world with currency, it eventually undermines confidence in that currency.
By the late 1960s, exactly this had happened. France, under President Charles de Gaulle, began converting its dollar reserves to gold, partly out of economic concern and partly to make a political point about American dominance. Other countries followed. The gold drain became unsustainable.
On August 15, 1971, President Richard Nixon announced that the United States would no longer exchange dollars for gold. The Bretton Woods system collapsed. And something remarkable happened next: nothing much changed.
The Fiat Dollar
This is the world we live in now. The dollar is backed by nothing except confidence in the American economy and the American government. There is no gold in Fort Knox that you can claim in exchange for your dollars. The same is true of euros, yen, pounds, and every other major currency.
Economists call this a "fiat" currency system, from the Latin word for "let it be done." The money has value because the government says it does—and because everyone agrees to act as if it does.
The surprising thing is how well this has worked. Since 1971, the dollar has remained the world's dominant reserve currency, though its share has declined gradually from around seventy percent in the 1990s to roughly fifty-eight percent today. The euro holds second place with about twenty percent, having inherited the status that the German mark held before European monetary union.
Other currencies play smaller roles: the Japanese yen, the British pound, the Chinese renminbi, the Swiss franc. Central banks have increasingly diversified into what economists call "nontraditional" reserve currencies—the Australian and Canadian dollars, the Swedish krona, even the South Korean won. This diversification is partly about seeking better returns, but it's also a form of insurance against the possibility that the dollar might someday lose its privileged position.
Network Effects and Lock-In
Why doesn't the reserve currency change more often? Part of the answer is simple inertia, but there's a deeper economic logic at work.
Economists talk about "network externalities" or "network effects"—the idea that some things become more valuable as more people use them. A telephone is useless if you're the only person who has one; it becomes more valuable as the network expands. The same logic applies to currencies. If everyone invoices international trade in dollars, and everyone denominates international debts in dollars, then it makes sense for you to do the same. Switching to a different currency would require coordinating with all your trading partners, your creditors, your debtors. The transaction costs would be enormous.
This creates a powerful lock-in effect. Even if the Chinese renminbi or the euro might theoretically serve equally well as a global reserve currency, the costs of switching are so high that the dollar tends to maintain its position—unless something dramatic happens to shake confidence in it.
The Privileges and Burdens
Being the reserve currency country is not an unmixed blessing. Yes, America can borrow more cheaply than it otherwise would. Yes, American consumers enjoy access to imported goods at relatively low prices. But there are costs too.
Because the world wants to hold dollars, the dollar tends to be stronger than it would otherwise be. This makes American exports more expensive on world markets, which hurts American manufacturers and their workers. The persistent trade deficits that result from reserve currency status have contributed to the hollowing out of American manufacturing over the past several decades.
There are political complications as well. The dollar's centrality to the global financial system gives the United States enormous leverage. American sanctions can cut off countries, companies, and individuals from the international banking system—a power the United States has used with increasing frequency. In 2014, the French bank BNP Paribas paid nearly nine billion dollars in fines to the United States for violating American sanctions, even though the transactions in question were legal under French law and involved no American parties except for the use of the dollar.
This kind of power breeds resentment and, eventually, efforts to work around it. China and Russia have signed currency swap agreements to reduce their dependence on the dollar. Various countries have discussed alternatives to SWIFT, the dollar-dominated messaging system that banks use to conduct international transfers. So far, none of these efforts have seriously threatened the dollar's position—but they are straws in the wind.
Could the Dollar Lose Its Crown?
History suggests that reserve currencies do eventually lose their dominant status—but the process usually takes a long time. The pound sterling remained widely held for decades after Britain ceased to be the world's leading economic power. The transition from sterling to dollar dominance was gradual, driven by two world wars, the rise of American industry, and the deliberate decision at Bretton Woods to put the dollar at the center of the new system.
What would it take to displace the dollar today? The most plausible challenger is the euro, which benefits from the economic size of the eurozone and the stability of the European Central Bank. But the euro has its own problems. The sovereign debt crisis of 2010 to 2014 revealed that a currency shared by nineteen different countries, each with its own fiscal policy, is inherently fragile. At the height of the crisis, serious analysts questioned whether the euro would survive at all. It did survive, but it lost ground in global reserves.
The Chinese renminbi is another possibility, though a more distant one. China now has the world's second-largest economy, and the renminbi has been added to the basket of currencies that make up the International Monetary Fund's Special Drawing Rights—a mark of respectability. But China maintains capital controls that limit the renminbi's usefulness for international transactions. And the Chinese government's willingness to intervene in financial markets makes investors nervous about holding large quantities of Chinese currency.
Perhaps the more interesting question is whether the future will be dominated by any single currency at all. Before World War One, multiple currencies shared reserve status—the pound, the franc, the mark—reflecting a world in which multiple powers competed for economic dominance. Some economists argue that we may be returning to a similar multipolar arrangement, with the dollar, euro, and perhaps the renminbi each playing significant roles.
The International Monetary Fund, after the economic disruptions of 2020, called for "a new Bretton Woods moment"—suggesting that the global monetary system might need to be redesigned from the ground up. What that would look like remains unclear.
The Long View
Stand back far enough, and the pattern is unmistakable. The Greek drachma gave way to the Roman denarius, which gave way to the Byzantine solidus, which gave way to the Islamic dinar, which gave way to the Venetian ducat, which gave way to the Spanish dollar, which gave way to the British pound, which gave way to the American dollar.
Each transition reflected deeper shifts in military power, economic production, and political stability. The currency of the hegemon became the money of the world—until the hegemon declined and someone else took its place.
The dollar's position today rests on the size of the American economy, the depth of American financial markets, the stability of American political institutions, and the sheer habit of decades. All of these could change. Some of them are changing already. In 2025, after new tariffs created uncertainty about American trade policy, financial institutions began openly questioning whether the dollar's reserve currency status could be taken for granted.
But if history is any guide, the transition—if and when it comes—will be gradual. Central banks move slowly. Financial systems have enormous inertia. The pound took decades to yield to the dollar, and the dollar has already maintained its dominance for longer than the pound ever did.
In the meantime, the money in your pocket—or more accurately, the numbers in your bank account—derives its value from a complex web of international confidence, historical accident, and institutional habit. It works because we all agree that it works. And it will keep working until, someday, we don't.