Reserve currency
A currency, chiefly the US dollar, that central banks and cross-border commodity trade prefer to hold and settle in, because it is the most widely accepted and convertible currency.
In plain language
When countries trade commodities across borders, they need a currency both sides trust. One currency has held that role for decades.
The US dollar is the world's primary reserve currency. Commodities such as crude oil, gold and silver are priced and traded internationally in dollars, which is why a swing in the dollar's own value moves commodity prices worldwide, even when nothing about supply or demand has changed.
How it works
The workbook, in Chapter 11.3, describes the US dollar as having "assumed the importance as international reserve currency due to the preference by central banks of many countries," with the Euro as the second most preferred currency for quoting and settling commodity trade. To track the dollar's overall strength, the workbook uses the dollar index, "a measure of strength of U.S. Dollar against six major currencies viz., Euro, Japanese Yen, Pound Sterling, Canadian Dollar, Swedish Krona and Swiss Franc" — 6 currencies in total.
The direction is consistent: "when the dollar strengthens... commodities typically become more expensive for buyers using non-dollar currencies," reducing demand and pressuring prices down; a weaker dollar works the other way.
A worked example
Illustrative. The US dollar weakens 5% against the dollar index basket. Gold, priced internationally in dollars, becomes cheaper for a non-US buyer even before gold's own dollar price changes — demand from buyers such as Indian jewellers tends to rise as a result, which is part of why gold and the dollar index are described as moving in opposite directions.
Why NISM asks about it
Chapter 11.3 (Currency and dollar index impact on commodities) sets out the dollar's reserve-currency role and the dollar index's six-currency composition. Expect a question naming the six currencies in the dollar index, or one testing the direction of the dollar-commodity relationship.
Common exam traps
- Reserve currency status is about central bank preference and convertibility, not a commodity peg. The workbook ties the dollar's role to post-war convertibility and central bank acceptance, not to gold or any other commodity backing it.
- The dollar index measures the dollar against six specific currencies, not against the rupee and not against commodities directly.
Check yourself
1.The dollar index measures the strength of the US Dollar against how many major currencies?
- a)Four
- b)Six
- c)Ten
- d)Twelve
Show the answer
Answer: (b) Six
The dollar index is a measure of strength of U.S. Dollar against six major currencies viz., Euro, Japanese Yen, Pound Sterling, Canadian Dollar, Swedish Krona and Swiss Franc.
Why it exists: all those factors which influence each of the major currencies like Euro, UK Pound, Japanese Yen, make it complex for any analyst to assess their impact on commodity price movements. Hence, the dollar index was discovered to gauge the overall currency movement. It is an easy way to analyze the impact of significant international currencies on the prices of commodities.
Why the dollar in the first place: US Dollar, right from the post world war period, has established itself as the most preferred internationally convertible currency. It has assumed the importance as international reserve currency due to the preference by central banks of many countries. Therefore, commodities' trade across the world uses US Dollar, then followed by Euro, as the two most preferred currencies to quote and trade in the commodities.
The Swedish Krona is the member candidates most often forget, and the Australian Dollar and Chinese Yuan are the two most often wrongly added.
And why it matters: since most commodities — such as crude oil, gold, silver, and agricultural products — are priced and traded internationally in U.S. dollars, any fluctuation in the dollar index directly impacts their value.
Where this is taught
Free preparation for NISM Series XVRelated terms
- BrentThe benchmark crude oil price for oil produced in Europe and Africa, sourced from the North Sea and traded on ICE — one of the two global oil pricing benchmarks alongside WTI.
- NYMEXThe New York Mercantile Exchange, the global benchmark exchange for trading energy commodities — where WTI crude oil is priced and traded.
- OPEC+A group of the 13 OPEC members plus Russia and other allied producers that coordinates crude oil output, together shaping a majority of the world's oil supply and reserves.
- Foreign bondAn external bond issued in a foreign country and denominated in the local currency of that same foreign country — such as an Indian company issuing US dollar bonds in the United States.
- Euro bondAn external bond issued in a foreign country in a currency that is not the local currency of that country — nothing to do with Europe or with the euro.
- Dollar indexA measure of the strength of the US dollar against six major currencies, used by commodity analysts as a single gauge of currency movement instead of tracking each one.