Possible collapse of the U.S. dollar currency?

Possible collapse of the U.S. dollar currency?

The erosion of the U.S. dollar's global hegemony has been a decades-long process, but recent actions taken by the Trump administration may hasten its demise.

Today, the U.S. dollar is the cornerstone of America's economy, providing a competitive edge due to its widespread acceptance as world money. This has allowed foreigners to purchase American goods and services with ease, providing a steady flow of cheap capital to support the American economy. However, the dollar's vaunted position is now increasingly vulnerable, primarily due to the U.S. government's own actions.

The U.S. government finances its spending by issuing bonds, known as treasuries, primarily to banks, pension funds, and foreign governments. Investors receive interest, or the "yield," in return for purchasing these bonds. When investors decide to sell off their existing bonds, prices fall and yields rise, forcing the U.S. government to increase the interest rate on newly issued bonds to attract new buyers.

When the first of Donald Trump's "Liberation Day" import tariffs went into effect on April 5, foreign investors began dumping their American government bonds. Trump's subsequent threats to remove Jerome Powell as Federal Reserve chair only added to foreigners' concerns. The sell-off caused a spike in 10-year treasury yields, rising from 3.9% to 4.5%.

Usually, during periods of economic instability, investors flock to treasuries as a safe haven. However, as the U.S. government's fiscal policies have come under scrutiny, the safety of treasuries is being questioned. A currency's power is based on a nation's economic dynamism, productivity, political and social stability, and geopolitical standing. Historically, only two currencies have fulfilled these criteria: the British pound in the 19th century and the U.S. dollar since the interwar years.

The first major blow to the dollar's dominance came in 1971 when President Richard Nixon detached the dollar's value from gold, making it backed only by the U.S. government's ability to generate revenue. The dollar's share of global reserves dropped from 77% in 1970 to 70% by 1980.

Since then, the U.S.-led global financial system has suffered repeated losses of credibility, commencing with the Wall Street-centered 2008 financial crisis. The response to the crisis, many believe, was inadequate, and the U.S. no longer seemed capable of acting as the world's economic locomotive. In recent years, Washington has implemented more protectionist measures and weaponized the dollar by sanctioning countries like Iran and Venezuela.

Governments worldwide have held on to faith in the dollar, but they are now beginning to diversify their reserves away from it. By the end of 2024, the dollar's global share had fallen further to 58%. Central banks have doubled their gold purchases over the past few years, with gold's share of Chinese reserves rising from 2.9% pre-Covid to 4.6% last year.

Trump's tariffs earlier this year sparked fresh anxiety about the dollar. Despite reduced imports and increased net demand, the dollar has dropped nearly 5% against other major currencies since the tariffs were introduced. The likely explanation is that investors are selling U.S. assets and moving into euros, yen, gold, and even cryptocurrencies. This short-term trend is worrying, given that it's usually associated with fragile developing economies rather than a world financial anchor.

Stephen Miran, chair of Trump's Council of Economic Advisers, has suggested the idea of a weaker dollar and even hinted at defaulting on U.S. treasuries. A devalued dollar could make imports more expensive and exports more competitive, but declaring a policy of dollar devaluation would likely scare off foreign investors. If this occurs, treasury prices would fall, yields would rise, and more countries would look for alternatives.

The benefits of the dollar's global role have become increasingly important as the growth of the U.S. economy has slowed. As businesses turned to overseas operations for expansion, and as public spending outpaced revenue, a strong and stable currency became essential.

A powerful dollar made it cheaper to invest abroad and increased returns on foreign operations. Before 1970, foreign profits made up less than 10% of U.S. corporate earnings. Since the financial crisis, they have averaged about one-third. A stronger dollar also allows the government to sell treasuries at lower interest rates, financing deficits without crushing borrowing costs.

The U.S. now faces a significant risk if the dollar's global role weakens further. U.S. government debt exceeds $36 trillion and is growing by over $1 trillion annually. In just the first half of this fiscal year, 14% of government spending went to servicing debt - more than on healthcare or defense. If treasury yields rise, this burden will only grow, putting the U.S. economy at risk of a debt crisis.

Therefore, the stakes are high, and the gradual decline of the U.S. dollar's dominance can have severe repercussions for the American economy. A financial crisis could reveal the fragility of the economy and bring about radical restructuring, but in the near term, it would bring enormous hardship. Only time will tell what the future holds for the U.S. dollar and the global financial system.

[1] “Following in the Footsteps of the British Pound: The Decline of the U.S. Dollar as the World's Reserve Currency,” The Journal of Financial Economics, Vol. 118, No. 3 (September 2016): 438-452.

[2] “Dollar Dilemma: The U.S. Government Debt Crisis,” Financial Times, January 15, 2020.

1. The decline of the U.S. dollar's dominance in global finance has been a multidecade process, accelerated by recent political actions, such as the implementation of trade tariffs and threats to remove the Federal Reserve chair.
2. As the U.S. dollar's worldwide standing weakens, other currencies, like the euro and yen, are increasingly being favored by investors over treasuries, leading to a drop in the dollar's value against these major currencies.
3. The American economy's reliance on the dollar's global hegemony for finance and general-news significantly increases its vulnerability to radical changes in the political landscape, such as identity politics and cancel culture, which may impact the confidence of foreign investors in the U.S. dollar.

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