The dollar - past, present, future
The dollar’s position as the world’s reserve currency, a position it has held since at least 1945, could be under threat.
Recent weakness in financial markets has been accompanied by a sell-off in the US dollar. Along with a sell-off in equities and bonds, the dollar has fallen to its lowest level since 2022, down over 9% against a basket of currencies since the start of the year.
This inverts the usual relationship in which investors move into dollars in times of elevated risk. America’s vast economy, backed by strong institutions and stable government, has long been seen as a safe haven in times of elevated risk. Yet recent uncertainties, triggered by shifts in US trade policy have seen investors shun the dollar and flock to other currencies, including the Swiss franc and the Japanese yen. Yesterday’s further sell-off in US equities and the dollar came in the wake of a social media post from Donald Trump calling on the Federal Reserve to cut interest rates immediately. The Fed has significant operational independence, including over interest rates, and such interventions are highly unusual.
Under current plans, US tariffs are set to rise to the highest level since the 1930s, more than ten times higher than at the start of this year. This is arguably the most momentous break in US economic policy since America’s abandonment of gold convertibility in 1971. The current US administration’s departure from the free trade consensus of the last 80 years has prompted speculation about previously unthinkable outcomes, such as selective treasury defaults or the withdrawal of federal dollar swap lines to allies.
The sell-off in the dollar, shifts in US trade policy and speculation about even more radical policies – all raise the question of whether the dollar’s position as the world’s reserve currency, a position it has held since at least 1945, could be threatened.
Reserve currencies are held in significant quantities by other central banks as part of their reserves – which can be used if necessary to buy imports, meet international debt obligations or influence the domestic exchange rate. Currencies held by central banks tend to be those most widely used in international trade and finance. The essential characteristics of a reserve currency is that it is convertible, backed by credible economic policies and has scale. For at least 80 years no country has come close to matching the US dollar on these criteria – and as the dominant reserve currency.
The US accounts for about a quarter of global GDP yet close to 60% of the world’s official foreign currency reserves are in dollars. The dollar is involved in 88% of all foreign exchange transactions. 70% of international bond issuance, 60% of all international loans and deposits and over half of all trade are denominated in dollars.
Critics contend that the dollar gives the US an outsize influence in the world and provides the US government with cheap credit because foreign demand for Treasuries drives down borrowing costs. In the 1960s, France’s then minister of finance, Valéry Giscard d'Estaing, famously claimed that the dollar gave America an “exorbitant privilege”. The phrase has stuck.
America certainly benefits from the dollar’s role as a reserve currency, but the size of these benefits is contested and they are not without costs. In a recent paper for the American Enterprise Institute by two former US policymakers, Steven Kamin and Mark Sobel, argued that the economic benefits of dollar dominance for the US were unlikely to be huge nor are the costs imposed on trading partners likely to be significant (AEI Economics Working Paper 2024-02, January 2024). For Kamin and Sobel the dollar’s greatest value to the US lies in geopolitical, not economic sphere, and the ability it gives the US to sanction ‘bad actors’ around the world.
By facilitating global trade and commerce, the dollar has created large net benefits for the rest of the world. The globalisation and economic growth of the post-war period have been built on dollar stability. It is hard to see how any other currency could have fulfilled this role – no other currency has the credibility, the scale, in terms of domestic debt issuance and the convertibility of the dollar. Private cryptocurrencies, which are sometimes touted as a reserve currency, are currently too volatile, illiquid and poorly regulated to do the job.
A potential disadvantage for the US of the dollar’s global role is that it creates excess demand for dollars, artificially inflating its value. Again, the precise effects are contested. But last year Mr Trump took up the theme, saying a strong dollar had been a “tremendous burden” on US industry. Before he became head of Mr Trump’s Council of Economic Advisers, Steven Miran, last year wrote a paper arguing that the US should seek to weaken the dollar to counter the effects of supposed overvaluation caused by its reserve currency status (Mr Miran has since distanced himself from these conclusions and said that the paper does not represent the position of the administration).
The central question is whether the dollar’s global status is good for the US. That has certainly been the view of successive generations of US politicians and policymakers. At the Bretton Woods Conference in 1944 American negotiators set out to supplant sterling as the dominant world currency. They succeeded, and subsequent US administrations held to the view that the dollar’s global role is a strategic asset. The current administration has not suggested that it takes a different position. But uncertainty about economic policy and the administration’s wider aims, especially in relation to trade, have reopened a familiar question about the role of the dollar.
The dollar is fundamental to the operation of the global economy and has been for many decades. The absence of any real contender for the role of global reserve currency means that dollar dominance looks as if it has much further to run. Yet while it may lack competition, the dollar is not unassailable.
Confidence in US policy and institutions is what gives the dollar its power. The sell-off in the dollar suggests a lack of confidence. This is not about external challenges to the US. As Kamin and Sobel conclude, “The United States is ultimately the biggest threat to global dollar dominance.”
A personal view from Ian Stewart, Deloitte's Chief Economist in the UK. Subscribe and/or view previous editions of the Deloitte Monday Briefing here.