The global currency market sees about $5.3 trillion traded per day. That amount is so vast that it would take a month of trading on the New York Stock Exchange to equal the amount of forex trading in just one day.
By value, the top 5 traded currencies are the US dollar, Euro, Japanese Yen, British Pound, and Australian Dollar.
The US dollar is by far the most important currency in the world and is also a reserve currency. That means that governments all over the world hold large amounts of greenbacks because a reserve currency is kind of like a world currency. Suppose Egypt wants to trade with Argentina. The Egyptians want Argentinian beef but the Argentines don’t necessarily want to conduct the transaction in Egyptian pounds as holding Egyptian currency isn’t that useful to them. Both parties might agree then to conduct the trade using US dollars.
It is the dollar’s status as the most dominant reserve currency that leads it to be the most important currency and most widely traded one to boot, representing nearly half of all forex trades.
If the Dollar is the gold-medallist in the forex Olympics, then the Euro would take the silver. The Euro is the second-most held reserve currency. In fact, all the top five traded currencies are reserve currencies – which explains in part why they are traded so much.
After World War II, the German Deutsche mark was the most-important reserve currency after the dollar. Once the Euro came into force, replacing the Deutsche mark and other European currencies, it retained the title.
At nearly $6.8 trillion, the Japanese economy is one of the biggest, and the Yen has a similar place of importance in the forex world. Originally introduced in 1871, the value of Yen was fixed to silver and gold, much like other currencies at the time. After World War II, the Yen lost much of its value and ended up being fixed at the rate of 360 yen to 1 dollar. Today one US dollar is worth 113 Yen (as of October 25, 2017).
The British Pound was the world’s dominant reserve currency for much of the 19th century as well as the first half of the 20th century, just as the British Empire started to fold. In 1950, the pound sterling accounted for more than half of the world’s foreign currency reserves. Just a few years earlier, sterling made up nearly 90% of global forex reserves.
Today it only makes up about 5%-10% of all currency trading and consistently makes up under 5% of all forex reserves.
The decline of the British pound is a story that the US should remember, as a once dominant currency can easily fall of its lofty perch within a decade.
Australian Dollar/Canadian Dollar
We mentioned earlier that countries like to hold foreign currency in reserve, to better facilitate trade or even to manage their credit more efficiently. We know about how the US dollar is the most popular reserve currency, making up more than 60% of all foreign currency reserves. Next is the Euro, followed by the British pound and the Yen. Of the 5% of foreign reserves that are marked as “other,” the Canadian and Australian dollar are often the currencies that are most widely held. The Swiss franc isn’t far behind.
Sometimes a great legacy or history dictates whether or not a currency becomes a reserve currency and by extension, an “important” currency. Other times it is purely market forces that create reserve currencies. For instance, the Canadian dollar acts as the second currency for American markets (north and south), and there are also a lot of trade links between Canada and Europe that pushes demand for Canadian currency.
What do you think the next dominant reserve currency will be? The Chinese Yuan? Indian Rupee? Or maybe even the Russian Ruble?