What is a reserve currency, anyway?

There are many factors that go into creating a world reserve currency, including the non-quantifiable factor of trust in the country’s government — that is, long-term economic, military, and political stability.

Stability of the currency itself is another requirement, as are deep and liquid capital markets. Another critical component is the need for that currency to be viewed as an international medium of exchange. Also, a world reserve currency can be viewed as a haven during time of turmoil.

“Its value is backed even in times of instability,” says Charmaine Buskas, economist at Moody’s Economy.com. “The government guarantees its value — it’s a risk-free asset.”

Although it might seem like the dollar has always been the world’s reserve currency, that has not been the case. Academics generally point to the end of World War II as the time when the U.S. dollar took over the role from the pound sterling, which was still basking in the afterglow of the British Empire’s apex in the early part of the century. The question at hand, of course, is whether that position is about to be wrested away from the dollar in the foreseeable future.