As we’ve discussed previously, for more than 80 years the US dollar has sustained its status as the world’s dominant reserve currency. It plays an important role as a store of value and it serves as grease that helps global financial systems operate efficiently. For one, the dollar is overwhelmingly predominant in the global market, accounting for almost 60% of all foreign exchange reserves. Sadly, this extraordinary position has held up since the conclusion of World War II. Under the current administration, concerns are mounting regarding the sustainability of this status as President Trump’s policies begin to undermine the dollar’s stronghold.
Throughout history, the dollar’s role has been the first choice as the medium of exchange in international trade, allowing parties to transact across borders with minimal friction. That said, huge recent swings in its price have understandably triggered concern. The dollar is down more than 1% against a basket of other currencies. Since the beginning of the year, it has tanked nearly 10%. At present, it stands at its lowest point in three years. This decline begs the question of what this means for the future of global trade and finance.
The Trump administration’s view on the dollar’s reserve status is a bit more nuanced. Others key players within his administration have long hated the dollar’s global reserve currency status. They view it as a cause that other countries are beating the United States on. Despite the problematic nature of this sentiment, it has been shaping harmful policy decisions that risk undermining the dollar’s precedence in global markets.
“The damage has been done,” – George Saravelos, head of foreign exchange research at Deutsche Bank.
For Saravelos at Deutsche Bank, President Trump’s latest moves are probably already accelerating the decline of dollar dominance. This change would set off a cascading wave of increased market volatility across the globe. The increasing US economic policy uncertainty—especially as it relates to tariffs—has escalated investor fears that the US is heading toward an economic recession.
Raghuram Rajan, a former governor of the Reserve Bank of India, raised alarm bells over US policy. He emphasized the unpredictable nature of its roll out and the major impact it could pose. He said this was compounded by the volatility and unpredictability of US policy. He’s increasingly concerned that if these high tariffs stick around, we’re looking at a recession in the US. Rajan emphasized that tariff policies have turned into a moving target, adding another layer of uncertainty for investors.
The possible consequences of these changes reach is far beyond the US borders. As every other country in the world tries to figure out how to deal with both the US and China, they will find themselves in a tight spot. His remarks echoed a critical statement made recently by Karsten Junius, the chief economist at J Safra Sarasin Sustainable Asset Management. For countries, the alternative is to have to pick a side, which is problematic, particularly for European and East Asian countries with important relationships with both Washington and Beijing.
Qualifiers aside, there are renewed calls for other currencies to take center stage. José Luis Escrivá, governor of the Bank of Spain and a member of the European Central Bank’s governing council, underscored the importance of stability and predictability in economic policies. Mr Carney made clear that in addition to the strong currency we can offer a deep economic space. These benefits are due to stable and predictable environments, made possible by good economic management and the rule of law.
The European Union has been named as a likely candidate to build a coalition of support for creating a rival to the dollar. Pascal Lamy, former EU trade commissioner and ex-head of the World Trade Organization, argued that the EU is uniquely positioned to lead this effort. Further, he noted, “Clearly the EU is the only candidate strong enough to bring a number of others along. If China or even India attempts it, it just won’t work.”
Still, Lamy cautioned that any move to reduce dependence on the dollar would be likely to take place over many years. As he said, “This is an American crisis, not a global crisis … The US only represents 13% of world imports. There’s no reason the other 87% of the world should be affected by these voodoo economics.” More and more people think that U.S. policies affect international markets. They don’t necessarily control everything that plays out in those markets.
As these dynamics play out, they carry profound implications for global finance and trade. The dollar has had an “exorbitant privilege,” allowing the US to run trade deficits since the 1970s. This advantage might be at risk if the current trends continue. A shift in tone towards currencies other than the dollar could send US investors running for the exits. They are looking too for signs of coalition-building between countries that are unhappy with US economic leadership.