President Donald Trump’s chaotic actions with respect to trade and American geopolitical interests vis-à-vis Russia, Ukraine and Europe have unleashed a new round of chatter over the perennial question – what does this mean for the future of the dollar’s global reserve currency and financing role?
Our bottom line remains that there is no viable alternative to the dollar’s global dominance for the foreseeable future, but that Trump’s actions may accelerate a secular decline over time in dollar dominance and in the process exacerbate financial market volatility.
In our previous work on the dollar’s global role, we pointed to three key considerations with respect to upholding future dollar dominance: preserving the underpinnings of the dollar’s global role; maintaining trust in the US as a reliable partner; and avoiding overuse or abuse of financial sanctions.
Underpinnings of the dollar’s global role are being weakened
The dollar is the world’s dominant currency because the US economy is huge, some 25% of global gross domestic product, and more innovative, entrepreneurial and faster-growing than nearly all its advanced-economy counterparts. America’s financial markets are the deepest, most liquid and open in the world. Macro policy over time has been relatively sound. Rule of law and institutions have been strong. The dollar network is global, which in turn reinforces its ability to fulfil the functions of a global currency — it’s a unit of account, a medium of exchange and a store of value. Inertia reigns – if it ain’t broke, why fix it?
Trump is weakening many properties that underpin dollar dominance. America’s fiscal trajectory is already unsustainable and yet Trump plans to cut taxes. Notwithstanding whatever fiction is asserted about a surge in potential US growth due to tax cuts or massive budget cuts by the Department for Government Efficiency helping balance the budget, already excessive debt and deficits are well poised to go higher. Team Trump has alluded to levies on capital inflow or taxes on those who might shun the dollar. While the Federal Reserve’s capacity to set monetary policy hasn’t been questioned yet, the Trump administration is taking a capricious and whimsical axe to many basic government programmes.
The world is openly questioning whether the US is a reliable partner
US post-second world war hegemony has provided a security umbrella, facilitating enormous global and transatlantic prosperity and the dollar’s role. As a Fed staff paper concluded: ‘around three-quarters of foreign government holdings of safe U.S. assets are by countries with some military tie to the U.S’. That hegemony was built up via US support for institutions such as Nato, the International Monetary Fund and the World Bank, the creation of the European Union, America’s backing for liberal trade and the World Trade Organization, and America’s longstanding support for democracy and territorial integrity while fighting the Soviet Union throughout the cold war.
These too are now under siege. Trump is putting his thumb, if not his fist, on the scales, backing Russia against Ukraine. Europe has long shirked its defence responsibilities – and it is highly welcome that it may now step up – but is openly questioning whether the US is abandoning Nato and taken umbrage at the suggestion that the EU was created to ‘screw’ America.
Trump is also threatening, and in some cases implementing, tariffs, and not just against China, but partners such as Europe, Mexico and Canada. Moreover, the chaotic way in which tariffs and tariff threats are being rolled out and then mercurially pulled back has sown confusion among businesses and undermined confidence and investment.
Of course, the administration is also seeking to eviscerate American development assistance, especially humanitarian and medical support, which has stemmed famine and the loss of lives throughout Africa. The dismantling of the United States Agency for International Development is weakening the US’s projection of ‘soft power’ abroad, ceding the economic and political high ground not only to Russia in Africa but to China in Latin America.
The bottom line is that the world is losing trust in America as a reliable partner as so eloquently stated by an ardent transatlanticist and soon-to-be German Chancellor, Friedrich Merz.
Financial sanctions and weaponisation
Secretary of the Treasury Scott Bessent in a welcome statement said: ‘President Trump expressed his view that overuse of sanctions could affect the dollar’s supremacy. I couldn’t agree more and would add that, not unlike the overuse of antibiotics, the target becomes immune and mutates. Lackadaisical sanctions simply create new markets which then must be sanctioned and so on.’
It’s too early to tell how the Trump 2.0 administration will approach the use of sanctions. Sanctions deployed multilaterally and in pursuit of strategic objectives will raise far fewer questions about the dollar’s global role than the use of bilateral sanctions. However, administrations in need of sticks short of war to balance the carrots of diplomacy have increasingly resorted to sanctions, and given fraying US-European relations it may well be that multilateral co-operation on sanctions will weaken. The US and Europe may find themselves at loggerheads soon over removing sanctions on Russia.
Dollar dominance remains well entrenched. There are no viable alternatives for the foreseeable future, though a stronger European economy with more euro-safe assets could enhance the euro’s global role. But given growing distrust over US management of America’s economic and geopolitical foundations, investors may begin to search more intently for possible other dollar alternatives or workarounds. This may well heighten market volatility.
Undermining the foundations for dollar dominance most importantly is bad for the US, let alone for the dollar’s global role.
Steven Kamin is Senior Fellow, American Enterprise Institute, and a former Director, International Finance Division, Federal Reserve Board. Mark Sobel is US Chair, OMFIF.
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Image source: White House
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