What You Should Know About the World's Reserve Currency

The following is a transcript of "Money Girl's Quick and Dirty Tips for a Richer Life," a podcast from QuickAndDirtyTips.com. The audio program is available via RSS feed here and at TheStreet.com's podcast home page.

Hello and welcome to Money Girl's Quick and Dirty Tips for a Richer Life.

Today's topic: The world's reserve currency.

Recently, Alan Greenspan, the former U.S. Federal Reserve chairman, said it's possible that the euro could replace the U.S. dollar as the world's reserve currency of choice.

So what exactly is a reserve currency and why does it matter?

A reserve currency is money that's held by many countries as their foreign exchange reserves. It's also the currency that's typically used to price commodities, such as oil and gold, that are traded between countries.

A country whose currency is the predominant reserve currency benefits tremendously. In the case of the dollar, the U.S. benefits from the increased demand for the dollar that the reserve currency status creates. Other countries give the U.S. valuable goods in exchange for dollars issued by the Federal Reserve. They also lend the dollars they've accumulated back to the U.S. at low interest rates.

Most significantly, the U.S. benefits from importing these goods and exporting its inflation to other countries in the form of depreciating dollars.

More than 60% of the world's reserve currency is held in U.S. dollars.

So why would Mr. Greenspan think that the euro might replace the dollar as the world's predominant reserve currency?

For starters, the euro has been gaining ground as a reserve currency since it was introduced in 2002. Now, only five years later, approximately one-fourth of the world's reserve currency is held in euros.