Page 24 - Policy Economic Report - June 2024

POLICY AND ECONOMIC REPORT
OIL & GAS MARKET

Lessons from Economics

Reserve Currency

A reserve currency is a large quantity of currency maintained by central banks and other major financial
institutions to prepare for investments, transactions, and international debt obligations, or to influence
their domestic exchange rate. A large percentage of commodities, such as gold and oil, are priced in the
reserve currency, causing other countries to hold this currency to pay for these goods.

Holding a reserve currency minimizes exchange rate risk, as the purchasing nation will not have to
exchange its currency for the current reserve currency to make the purchase. Since 1944, the U.S. dollar
has been the primary reserve currency used by other countries. As a result, foreign nations closely monitor
the monetary policy of the United States to ensure that the value of their reserves is not adversely
affected by inflation or rising prices.

Benefits of Reserve Currency Status

• Being the country issuing a reserve currency reduces transaction costs, since both sides of the
transaction involve the same currency and one is yours.

• Reserve currency issuing countries are not exposed to the same level of exchange rate risk,
especially when it comes to commodities, which are often quoted and settled in dollars.

• Because other countries want to hold a currency in reserve and use it for transactions, the higher
demand means lower borrowing costs through depressed bond yields (most reserves are of
government bonds).

• Issuing countries are also able to borrow in their home currencies and are less worried about
propping up their currencies to avoid default.

Drawbacks of Reserve Currency Status

• Low borrowing costs stemming from issuing a reserve currency may prompt loose spending by
both the public and private sectors, which may result in asset bubbles and ballooning government
debt.

Dollar dominance in the International Reserve system

The post-war emergence of the U.S. as the dominant economic power had enormous implications for the
global economy.

• At one time, U.S. Gross Domestic Product (GDP), which is a measure of the total output of a
country, represented 50% of the world’s economic output. As a result, it made sense that the U.S
dollar would become the global currency reserve. Since then, other countries pegged their

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