Will the dominance of the US dollar disappear? Donald Trump insisted: "If we lose a dollar as the world currency... it would be the same as losing war." However, he himself may have caused such losses. Reliance on foreign currencies depends on their own integrity and trust in liquidity. Trust in the US dollar has slowly eroded for some time. Now, under Trump, the United States has become unstable, indifferent and even hostile: Why does one trust a country that launches a trade war against its allies?
But while outsiders may want to diversify from the dollar, they lack compelling options. So, what (if any) can replace its hegemony?
The US dollar has been the world's leading currency for a century. However, with the decline of Britain's power and wealth, the dollar itself replaced the pound after World War I. Objectively, the United States did not decline as it did in the UK: its nominal global GDP share was 26% in 2024, accounting for 25% in 1980, according to the International Monetary Fund. This is significant given the rise of China's economy during this period. The United States is also on the border between world technological development and the most important military force. Its financial markets are still the deepest and liquid. In addition, in the fourth quarter of last year, 58% of global reserves were US dollars, down from 71% in the first quarter of 1999, but 20% ahead of the euro. According to Macromicro, 81% of trade financing, 48% of international bonds and 47% of cross-border bank claims remain in US dollars.
What's wrong? Charles Kindleberger argues in his work on the international system that the stability of an open world economy depends on the existence of hegemonic powers willing and able to provide basic public goods: open trade markets; stable money; and a last resort in a crisis. The British offered all three until 1914. The United States did this after 1945. But during this period, the UK cannot - and the US will not offer these goods. The result is disastrous.
The era of US dollar hegemony caused many shocks. The post-war recovery of Europe and Japan undermined the fixed exchange rate system agreed by Bretton Woods in 1944. In 1971, President Richard Nixon was most similar to Trump, devalued the dollar. This, in turn, led to high inflation, which ended only in the 1980s. This also led to the creation of floating exchange rates and European exchange rate mechanisms, followed by the euro. Although economists tend to think that monetary reserves will no longer matter in the world of floating rates, especially all the Asian crises in the late 1990s, and numerous financial and currency crises showed the opposite. The load of the Federal Reserve has also proved to be ongoing importance, especially during the 2008-09 financial crisis.
In short, Kindleberger conditions are still important. It is also relevant, a broader view is that network externalities support the emergence and sustainability of major global currencies, as all users benefit from using the same currencies as other currencies and will continue to do so if they can. But what if the overlord uses every economic stick, including financial sanctions? What if hegemony threatens the invasion of friendly states and encourages the invasion of friendly states by dictators? What if hegemony undermines its own fiscal and monetary stability and the institutional basis for its economic success? What if its leader is an unprincipled bully?
Then both countries and individuals will consider alternatives. The difficulty is that no matter how satisfying Bamon may be, the alternatives look worse. The RMB may be the best currency used in trading with China. But China has a domestic capital market with insufficient capital controls and liquidity. Furthermore, these reflect the strategic priorities of the Communist Party of China, which is economic and political control. China also seems likely to use economic coercion as well. Therefore, China cannot provide the liquid and safety assets it provides in the history of the United States.
The euro does not suffer these obstacles to the RMB. Then, at least partly replace the dollar, because Hélène Rey of London Business School thinks? Yes, it may. But it also suffers from defects. The euro zone is scattered because it is not a political alliance, but a club of sovereign states. This political division also shows financial and economic divisions, which limit innovation and growth. Most importantly, the EU is not a hegemonic force. Its appeal may outweigh the worst at the moment in the United States, but it doesn't match America's best.
At that time, we competed between three alternatives, with some other options - a global currency or a world based on cryptocurrency - certainly unthinkable. The first option is the transformation of China or the euro zone, so one of them emerges as a hegemonic issuer. The second will be a world with two or three competing currencies, each dominant in different regions. But as people rush from one currency to another, network effects will create an unstable balance in such a world. Since then, it has been more like the 1920s and 1930s than the 1920s and 1930s. The third will continue in US dollars.
What kind of hegemony could this be? Ideally, the trustworthy America will reappear. However, given the damage caused now at home and abroad, this is becoming increasingly impossible. In the kingdom of the blind, a person with one eye is the king. Similarly, given the lack of high-quality alternatives, even flawed existing currencies may continue to dominate the currency world. Trump will like the world. Most of us won't.
martin.wolf@ft.com
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