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Central banks and financial institutions hold large amounts of foreign money as their reserve currency.

Reserve currency is important because it’s used to pay off international debt and to influence exchange rates between countries. Many countries hold commodities like gold and oil in their reserve currency, forcing other countries to do the same in order to pay for imported goods.

Holding currency reserves minimizes exchange rate risk as it allows two nations to conduct transactions with each other in the same currency. If Mexico buys goods from Canada, it can pay in U.S. dollars. If Mexico has to change its currency into Canadian dollars to make the deal, it runs the risk of losing value in the exchange. Citizens of a country that issues reserve currency to do business with other nations can benefit from not having to exchange their money.

If a country pegs its currency to another country’s currency, it can use its foreign reserves to maintain its own currency’s value. For example, if the pegged country’s currency rises in value, the other country can use foreign reserves to buy its own currency in the market. This will decrease the supply of the currency and increase its demand, thereby raising its value to keep up with the pegged nation’s currency. 

 

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