Understanding Key Currencies

A key currency refers to a currency which is stable, does not fluctuate much, and provides the foundation for exchange rates for international transactions. Because of their global use, key currencies tend to set the value of other currencies. Also, these currencies tend to have a stable valuation over time. A key currency usually comes from a country that is financially strong, economically stable and developed, and one that is involved in the global market.

Nevertheless, key currency rates do fluctuate daily, and updated key currency rates can appear in financial institutions and financial reporting outlets.

Key currencies form the reference value for international commerce transactions and as an exchange rate in the foreign exchange (forex) marketplace. An exchange rate is the price of a nation’s currency relative to another country's currency, and it includes the domestic currency and the foreign currency. International commerce is trade between companies in different countries or trade between different countries.

National central banks hold quantities of key currencies as reserve currencies. Reserve currency helps these nations support investments, complete international business transactions, and pay international debt obligations. These banks may also hold key currency to influence their domestic exchange rate. A large percentage of commodities, such as gold and oil, are priced in the key and reserve currency, causing other countries to hold this currency to pay for these goods. However, a currency used as a reserve currency may not be considered a key currency.

As a monetary practice, countries with weaker economies will align their exchange rates with a dominant trading partner. The central bank of some developing nations may fix their exchange rate to a key currency. Known as currency pegging, this practice has the effect of limiting monetary policy flexibility but can increase confidence in a country's economy.

While the term key currency is not precisely defined by any quantitative threshold for use or reference as a benchmark, some key currency examples can be identified based on their characteristics. The U.S. dollar (USD) has been the leading key currency in the global economy for over 70 years. In this role, the U.S. dollar is used to measure the value of other country’s currencies. Many other nations will invest in the U.S. dollar for its global value and stability.

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