The Dollar Still Rules, But US Policy Is Making It Less Special

President Donald Trump’s push to redesign the global economic order in favor of the US is shaking one of the foundations of its post-World War II supremacy: the dollar’s undisputed role as the world’s reserve currency.It’s a status that shows the dollar is used in roughly nine out of 10 foreign exchange transactions and about half of all merchandise trade conducted globally, and is making up almost 60% of reserves held by governments around the world. That dominance helps Washington to run gaping budget deficits and US consumers to spend more than they make—all funded by overseas investors eager to snap up assets denominated in greenbacks adorned with the motto “In God We Trust.”

But trust in the dollar is faltering. In 2022 the Biden administration’s curbs on Russia’s access to the currency after the invasion of Ukraine spurred a first round of diversification. If the US could freeze out the world’s 11th-largest economy, so deeply entrenched in global oil markets, is anyone safe? The Great Inflation, and a rapidly deteriorating fiscal trajectory since then, has added to doubts about American economic exceptionalism. And most recently, the haphazard rollout and rollback of Trump’s tariff campaign in April sparked a rare weakening in both the dollar’s value and that of US Treasuries. The US dollar index tumbled more than 10% in the first six months of the year, its worst first-half performance since 1973.

Like an uncorked genie, the “sell America” talk is proving hard to bottle up again. Banks and brokers are seeing rising demand for currency products that bypass the dollar, and some of Asia’s richest families are cutting exposure to US assets, saying Trump’s tariffs have made the country much less predictable. Geopolitical rivals within BRICS—a loose group of large economies led by Brazil, Russia, India, China and South Africa—are continuing their long push for a new cross-border payments system. Even long-term allies such as Europe see an opportunity to erode the dominance of the dollar.

Not everyone is so dour. JPMorgan Chase & Co.’s Jamie Dimon said in May that the US remains the most “prosperous, innovative nation on the planet” and that he doesn’t fret over short-term fluctuations in the dollar. Secretary of the Treasury Scott Bessent has tried to convince investors that the strong dollar policy remains intact, and his boss has threatened 100% tariffs against anyone who dares challenge it. Yet for all the tough talk, the reality is that the greenback’s greatest relative strength is actually the lack of any single challenger to its standing atop the global monetary order.

There’s talk of a “global euro moment” in which the European common currency plays a bigger role, but history has shown that the bloc struggles to move in sync, and its institutions are too fragmented to create the markets deep enough to rival those of the US. China’s central bank governor is talking up his nation’s currency as an option for those seeking to shift from the dollar, but it’s hard to imagine how that will be embraced when capital controls still impede the free flow of assets across Chinese capital borders.

Central banks and investors have piled into the ultimate haven asset—gold—but it’s cumbersome to hold, offers no yield and can’t easily be used in trade or financial transactions the way the dollar can. Speculation for dollar replacements range as far as Bitcoin and other digital assets, though few outside El Salvador (which in 2021 adopted the cryptocurrency as legal tender) are ready to shift toward anything that’s not government-backed. Other financial innovations such as stablecoins—digital tokens meant to substitute for traditional cash—may entrench rather than dislodge the dollar’s primacy as they peg their value to the greenback.

With no viable alternative to the US dollar as the world’s currency on the horizon, the more likely change is to a multicurrency world. The dollar would still be dominant, but other currencies would play a larger role. Although this may not be as revolutionary as a complete breakdown in the global monetary order that some dollar doomsayers are foreseeing, the resulting currency competition will still have profound effects on the US’s hard and soft geopolitical power. Indeed, no one is really ready for what a feeding frenzy of currency competition will mean in ­practice—especially not Americans.

The US would have to give up some of the benefits of the strong-dollar regime, a key one being lower interest rates as fewer overseas investors buy dollar-denominated bonds. Barry Eichengreen, an economist at the University of California at Berkeley, who’s written extensively on the dollar, has calculated that in a scenario where the US withdraws from the global stage, the dollar’s share of reserves in countries that rely on its security could decline by about 30 percentage points. Long-term US interest rates could increase by as much as 0.8 of a percentage point, he estimates.

US banks will need to pay more to raise money and charge more for mortgages as a result. Higher home loan rates tend to slow the economy because they leave less income for consumers to spend on vacations, home improvements and the like. And though a weaker foreign exchange rate may be good for rebalancing the trade deficit—by making American exports cheaper and more competitive and deterring spending on costlier imports—that’s not great for household wealth.

The federal government will also feel the pinch. It finances its annual budget gap, a little less than $2 trillion, through Treasuries. In a world where euro- or yen-denominated assets are more strongly vying for investor attention, borrowing costs for the US government would need to rise. In fact, we’re already noticing signs of that: Thirty-year Treasury yields have more than doubled since the start of 2022 and exceeded 5% at one point in May. That means America will pay more for new borrowing and more to keep rolling over its existing debt too. Annual payments on US government debt by some measures are now larger than what the country spends on national defense.

The globalized dollar has long shielded lawmakers in Washington from having to decide between guns or butter—or tax cuts. And even as doubts in the dollar grow as the budget deficit swells, legislators still aren’t ready to tighten their belts. Elon Musk promised $1 trillion in savings through the so-called Department of Government Efficiency, or DOGE; the cuts so far have saved less than $200 billion. Meanwhile, a key legislative win for Trump, the One Big Beautiful Bill, will add as much as $3 trillion to the budget deficit over the next decade, according to estimates from the Congressional Budget Office. But in a world where investors continue moving away from the greenback, markets could eventually force difficult trade-offs to cut the deficit—meaning that social safety nets and public research-and-development spending that’s long spurred private-sector innovation in areas including Big Tech and Big Pharma will start to have limits imposed on them.

A less hegemonic dollar would affect America’s geopolitical prowess. With a weaker currency, overseas military bases would become more expensive to keep up. With less use of the dollar in global transactions, economic sanctions would have less bite. And policing the financial system for malign activities, such as financing terrorist undertakings or laundering money, would be harder because flows outside of dollar-based networks won’t be visible to American policymakers.

“We don’t appreciate how good we have it,” says Josh Lipsky, senior director of the GeoEconomics Center at the Atlantic Council in Washington and a former adviser at the International Monetary Fund. “Ownership of the reserved asset means cheaper credit for Americans and the federal government, it means more transparency of US policymakers in the financial system to carry out economic statecraft that aligns with US foreign policy objectives. That is what’s at risk.”

US Treasury secretaries, the stewards of the dollar and American currency policy, have long said that it’s up to the nation itself to guard the treasure that the reserve asset is. Whether it’s Bob Rubin, Hank Paulson or Janet Yellen, these leaders have said that a strong economy bolstered by independent institutions and the rule of law will protect the dollar’s status. Yet the Trump administration has sent mixed signals. Bessent has stuck largely to the script of predecessors, but Stephen Miran, chair of the White House’s Council of Economic Advisers and Trump’s latest pick to serve as governor of the Federal Reserve, has referred to the dollar’s status as a “burden.”

Trump’s efforts to shift executive authority into independent agencies like regulators and even the Federal Reserve, his consistent challenges to the courts, and Washington’s disregard for record-high federal debt are adding to the dollar’s headwinds. Trust is the cornerstone of the world’s choice of the dollar as king, and Trump is chipping away at that credibility. “For the first time, the dollar’s future status may be determined by how other currencies develop,” Lipsky says. “And those will develop faster if people are looking for them—that’s the lesson of capitalism.”

The world economy is more financialized and knit together than the last time it saw a tectonic shift in global currency power about 80 years ago, when the dollar eclipsed the British pound. Indeed, the dollar’s status has faced a reckoning before and persevered. President Richard Nixon unilaterally abandoned the gold peg in 1971 and imposed a 10% import tariff after nations including France sought to swap dollars for bullion, threatening the monetary system agreed at Bretton Woods after World War II. The American-made global financial crisis earlier in the 2000s also triggered questions, particularly in China, about whether the US continued to merit its role as cornerstone of the global monetary order.

Previous eras have had mixed currency use, but typically those were anchored to either gold or silver. There’s never been a period when multiple fiat currencies competed for dominance. This fact makes some people nervous about what lies ahead. A multicurrency era could provoke instability as investors run from one to another in reaction to financial conditions, compounding the challenge for businesses already grappling with how they’ll rewire supply chains in an era of rising tariff walls.

Today’s steward of US currency policy, Bessent, is pushing back against the dollar doubters: “Since World War II, the demise of the dollar as a reserve currency has been predicted,” he said on Bloomberg TV on July 3. “Once again, the skeptic is going to be wrong.” And he’s right: The US dollar isn’t about to disappear from central bank hoards or as a medium for global finance. But it will face more competition in a multipolar world. And that will have unpredictable repercussions both at home and abroad.

Source: Bloomberg Europe