National Currency

What is a national currency?

A national currency is the legal tender issued by a country’s central bank or monetary authority. It serves as the primary medium of exchange for goods and services within that country and is typically backed by the government’s credit and monetary policy.

Functions and global role

• Medium of exchange: Used for everyday transactions.
• Unit of account: Provides a common measure for pricing goods and services.
• Store of value: Holds purchasing power over time, subject to inflation and monetary policy.
• Reserve currency: Some national currencies (notably the U.S. dollar, euro, and Japanese yen) are widely held by governments and institutions as foreign-exchange reserves and are commonly used in international trade and commodity pricing.

Some countries adopt another nation’s currency as legal tender (dollarization), for example Ecuador and El Salvador use the U.S. dollar. Others peg their currencies to a major currency to stabilize inflation and trade—an example is the United Arab Emirates’ peg to the U.S. dollar.

How national currencies are issued and maintained

National currencies are issued and regulated by a country’s monetary authority (central bank). In the United States, the Federal Reserve manages the money supply and monetary policy. The National Currency Act of 1863 established a uniform national currency in the U.S. and created the Office of the Comptroller of the Currency to supervise nationally chartered banks.

Trading national currencies

Currencies are traded as financial instruments on the foreign-exchange (forex) market, the world’s largest financial market. Key points:
– Forex operates 24 hours a day during business days and is dominated by trading in currency pairs (one currency exchanged for another).
– Trading activity often concentrates during the market hours of the currency’s home economy.
– Exchange-traded funds (ETFs) and other instruments have made it easier to gain exposure to individual currencies without trading forex pairs directly.

Pegging to the U.S. dollar

Many countries peg their currencies to the U.S. dollar to reduce exchange-rate volatility and control inflation. Currently, 23 currencies are pegged to the U.S. dollar; examples include the Lebanese pound and the Venezuelan bolívar.

Key takeaways

• A national currency is legal tender issued by a central bank and used as the main medium of exchange within a country.
• Major reserve currencies (USD, EUR, JPY) play outsized roles in international trade and finance.
• Some countries adopt foreign currency (dollarization) or peg their currency to a major currency to stabilize their economies.
• Currencies are actively traded on the forex market and can be invested in via pairs or currency-focused ETFs.

Conclusion

National currencies underpin domestic economic activity and influence global trade and finance. Their stability and international role depend on monetary policy, fiscal credibility, and the currency’s acceptance as a medium of exchange and reserve asset.