Introduction

In today's global economy, countries often use their own currency for international trade. However, this isn't always the case. While some countries do engage in trade using a common currency, the majority stick to their own domestic currencies. This practice offers numerous advantages, particularly in terms of efficiency and minimizing transaction costs.

The Role of Domestic Currencies in International Trade

Practically all countries use at least some of their domestic currency for international trade, though not for all transactions. For instance, many trades between the European Union (EU) and the United Kingdom (UK) are conducted in both pounds and euros. This is because, with sufficient bi-lateral trade, the costs of converting to a third currency can outweigh the benefits of using the currencies of the trading partners.

Case Study: France and the UK

Consider a hypothetical scenario where Company A, based in France, regularly buys and sells goods in the UK. The company opens a UK bank account and manages its transactions directly in pounds. When Company A ships goods to its UK subsidiary, the latter transfers the costs to a UK account of the parent company. Subsequently, the UK subsidiary sells these goods to consumers and is paid in pounds. This system ensures a smooth and cost-effective flow of pounds from UK consumers to the French parent company.

When the French parent company needs to buy raw materials from the UK, it already has a local bank account in UK pounds, enabling it to pay for the goods directly in pounds. This eliminates transaction fees, conversions, and problems associated with variable exchange rates, providing a more efficient and reliable process.

The Exception: Commodities and Benchmarks

While many countries opt to use their domestic currencies for international trade, there are exceptions. Certain commodities and benchmarks are often priced in major currencies like the US dollar, euro, or Japanese yen. For instance, the price of oil and wheat is frequently quoted in US dollars. However, when actual transactions occur, the involved parties may choose to use the trading partners' domestic currencies based on the prevailing exchange rates.

Emerging Markets and Currency Strength

In certain instances, a country's domestic currency may be perceived as weak or unstable. In such cases, it may be advantageous for that country to conduct its international trade using a more stable and widely accepted currency, such as the US dollar. This is a common practice among countries with weaker or unstable currencies, as seen with the Russian ruble during periods of economic instability.

The US Dollar as a Reserve Currency

The US dollar stands out as a reserve currency, widely used by other countries for international trade. However, it is not the primary currency used by all countries. The vast majority of countries outside the EU do not accept euros as their primary currency, with each country maintaining its own currency for daily transactions. Most European countries, for example, prefer to use the domestic currency for cash transactions, relying on bank accounts and electronic payments rather than physical cash.

For some countries, the US dollar serves as a reserve currency due to the stability and strength of the US economy. These countries use the US dollar for international transactions, particularly in sectors such as oil, gold, and other commodities.

Conclusion

In essence, while the US dollar and other major currencies are commonly used in international trade, particularly for commodities and benchmarks, a country can and often does use its own domestic currency for most of its trade transactions. This approach optimizes efficiency, reduces transaction costs, and aligns with the principles of free-market economic practices.