What is 'Key Currency'

The term key currency refers to a type of currency that is stable, does not fluctuate  much, and helps set key exchange rates and international transactions. Key currencies are “key” to setting the value of other currencies because they are used so widely across the world and because their own value tends to stay pretty steady.

A key currency typically comes from a country that is financially strong, developed and economically stable, and is involved in the global market. For example, the United States, the United Kingdom, Europe, Canada, Mexico, and Japan all have key currencies. The US dollar, British pound, the euro, the Canadian dollar, the Swiss franc, the peso, and the yen are all considered to be global key currencies.

BREAKING DOWN 'Key Currency'

Key currencies are used as a reference in an international transaction or when setting an exchange rate. Central banks also hold key currencies in reserve (reserve currency). Key currency rates do fluctuate somewhat daily and updated key currency rates can be found through financial institutions and financial reporting outlets, such as the Wall Street Journal.

As a monetary practice, countries with smaller or less-dominant economies sometimes align their exchange rates with the dominant trading partner. The central bank of some developing countries may fix the exchange rate to the key currency, which has the effect of limiting monetary policy flexibility but can also increase confidence in the country's economy. Essentially, by fixing their own currency exchange rates to key currency rates, they are hoping to make their own economy more stable and help international transactions easier.

Limitations of key currency

For over 70 years, the US dollar (USD) has been the leading key currency in the entire world. This means that not only does the US dollar play a role in setting the rate for the value of other country’s currencies, but that other countries invest in the US dollar for its value too. The fact that the US dollar is used as the “base” currency for other currencies and that other countries invest in it as a safeguard has the end result of a boosting circle for the U.S. by strengthening the dollar even more.

But some experts warn that having one country’s currency dominate all others for so long and so uncontested is ultimately going to end badly. Some experts believe it is much healthier, based on historical evidence, to have several leading key currencies on the market.

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