DEFINITION of 'Reserve Assets'

Currency, commodities or other financial capital held by monetary authorities, such as central banks, to finance trade imbalances, check the impact of foreign exchange fluctuations and address other issues under the purview of the central bank. Reserve assets should be liquid and under the monetary authority's control.

BREAKING DOWN 'Reserve Assets'

Before the Bretton Woods agreement ended in 1971, most central banks used gold as their reserve assets. Today, central banks may still hold gold in reserve, but this has been supplanted by reserves of foreign currencies. Currencies held by central banks have to be readily convertible, meaning that the currency should have high enough stable demand (and low controls) to allow the bank to use them.

Reserve assets can be used to fund currency manipulation activities by the central bank. In general, it is easier to push the value of a currency down than to prop it up, since propping the currency up involves selling off reserves to buy domestic assets. This can burn through reserves quickly. The central bank can put downward pressure on the currency by adding more money into the system and using that money to buy foreign assets. The downside to this strategy is the potential for increased inflation.

The U.S. dollar is widely considered to be the predominant reserve asset.

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