‘Exorbitant privilege': Can the US dollar maintain its global dominance?

Al Jazeera

6 days ago

Since the 1940s, the US dollar has held firm as the global reserve currency, driving international trade and reinforcing the status of the United States as an economic superpower.
In recent years, however, some countries have expressed opposition to the US dollar's longstanding economic dominance.
The BRICS economic bloc, named for its founding members, Brazil, Russia, India, China, and South Africa, has actively sought to reduce its reliance on the US dollar. China has even pushed for 'de-dollarisation', by promoting its currency, the yuan, and forming currency swap agreements with other countries.
Christine Lagarde, president of the European Central Bank, recently noted that a 'shift' was under way that would allow for the 'euro to gain global prominence'.
Lagarde said in June that the euro accounts for approximately 20 percent of global foreign exchange reserves, and that the 'dominant role of the US dollar', which accounts for 58 percent, 'is no longer certain'.
'History teaches us that regimes seem enduring – until they no longer are. Shifts in global currency dominance have happened before. This moment of change is an opportunity for Europe. It is a 'global euro' moment,' Lagarde said.
The dollar has also weakened this year, experiencing its sharpest six-month decline in decades.
Global investors have been reacting to policy uncertainty under the administration of US President Donald Trump, rising debt, and shifting interest rate expectations – with some questioning its 'safe-haven' appeal.
Experts say that in the unlikely event that the US were to lose its reserve currency status, the impact would be profound, as the country would lose much of its leverage to influence global trade and enforce sanctions – international trade that does not directly involve the US often runs through the dollar.
Or, as Trump told reporters earlier this month, 'If we lost the world standard dollar, that would be like losing a war.
'We would not be the same country.'
'Exorbitant privilege'
As the global reserve currency, the US dollar underpins a monetary system where central banks rely on it to stabilise their economies, manage debt and implement trade policies.
Historically seen as a safe investment, the dollar remains so deeply embedded in the global system that, despite recent shake-ups, it is unlikely to be dethroned anytime soon, emboldened by a longstanding history of resilience.
The US dollar was put on this course in the 1930s, when then-President Franklin D Roosevelt centralised US gold reserves and tied the dollar to a fixed supply of gold.
Then, in 1944, the US spearheaded the Bretton Woods Agreement, which pegged international currencies to the dollar, leading to the creation of the International Monetary Fund (IMF) and the World Bank.
With much of the world recovering from war and the US holding the majority of global gold reserves, the dollar emerged as the anchor of the post-war financial system, and by the 1960s, gave the US what former French Minister of Finance Valéry Giscard d'Estaing called an 'exorbitant privilege'.
In 1971, US President Richard Nixon severed the last remaining ties to the gold standard, an action that became known as the 'Nixon shock', allowing the dollar to float freely in the open market. Despite the wave of changes, the US economy remained strong, bolstered by its growth in manufacturing and information, which helped the dollar maintain its status.
Since the Nixon era, the dollar's dominance has mostly only strengthened, even as countries like China have outpaced the US in economic growth, population and manufacturing output. The US has continued to wield disproportionate influence through trade agreements and financial sanctions.
'Many times, even between emerging markets when one converts a currency, like the Brazilian real and the South African rand, for example, there is a transaction to US dollars in between, and so, the US extraterritorial power here stems from the fact that other countries, global banks, don't want to lose their access to the US dollar-based financial system,' Rachel Ziemba, adjunct senior fellow at the Center for a New American Security, told Al Jazeera.
This also adds weight when the US imposes sanctions.
'From a geopolitical standpoint, the US having a reserve currency gives it more flexibility to weaponise its currency via financial sanctions and the like,' Ziemba said.
Because transactions often pass through banks that work in tandem with the US Federal Reserve, they can be subject to US sanctions – even if the US is not directly involved.
That is why the financial sanctions imposed on Russia after its invasion of Ukraine led to a default on Moscow's sovereign debt. In 2022, sanctions from the administration of former US President Joe Biden effectively cut Russia off from dollar-based trade, freezing $300bn in assets held by its central bank and crippling its economy. As a result of the sanctions led by the US, Russia's gross domestic product (GDP) fell by $104bn.
If the dollar did lose its status, domestically, it would mean higher borrowing costs. Without foreign demand for US debt, interest rates would rise, driving up the cost of mortgages and credit cards. This is because private banks peg their interest rates to those of the Federal Reserve.
'It would mean the US no longer has this big pool of foreign savings to rely on to keep the US borrowing costs down. It's kind of a fundamental threat to the US economic model of the past few decades, which has generally been relatively low interest rates, which has enabled consumers, firms and the government to finance a lot of debt at relatively cheap prices,' Pearce said.
'A loss of dollar dominance for the US means higher interest rates in the US, and that's really going to put pressure on demand. Mortgages are gonna get a lot more expensive,' he added.
A new era of economic uncertainty
Unlike in Nixon's era, when US dominance was largely uncontested, the current global economy is more interconnected.
Emerging powers such as China and India have expanded their global influence, and alternative financial systems, including the rise of cryptocurrencies, have gained traction. Repeated policy whiplash from one US administration to the next risks undermining that stability in a landscape of growing threats.
Trump's erratic approach to tariffs and global agreements has revived doubts about the US's reliability on the world stage and raised long-term concerns about the stability of the dollar.
'I think Trump has done more than anybody in modern history to undermine key institutions,' said Alex Jacquez, a special assistant to the president for economic development at the White House National Economic Council under Joe Biden.
After Trump's first term, global partners felt the US had returned to diplomacy under Biden, Jacquez told Al Jazeera.
'When I came in with the Biden administration and worked on these issues, certainly, we had our disputes and our issues with our trading partners, but the international community welcomed us back with good-faith negotiations. But that came with scarring and pain with their interactions with the Trump administration.'
However, Jacquez noted that regaining that trust may now be harder. This is not simply because of Trump, but also because of the broader pattern of reversals in US policy that his administration has driven.
Jacquez argues that frequent U-turns, abrupt withdrawals from agreements and threats to longstanding alliances have created global instability, making it difficult for other nations to formulate long-term plans, which could compromise the long-term stability of the dollar.
That comes alongside Trump's tax legislation, which he recently signed into law, and is expected to add $3.4 trillion to the federal deficit. This is stoking fears about long-term US economic stability, potentially raising borrowing costs that could impact global investors, central banks and everyday consumers.
In 2023, then-Senator JD Vance questioned the value of the dollar as the global reserve currency in an exchange with Federal Reserve Chairman Jerome Powell.
'I think in some ways, you can argue that the reserve currency status is a massive subsidy to American consumers, but a massive tax on American producers,' Vance said.
But since Trump took office with Vance as vice president, tariffs have put pressure on US producers, not the status of the dollar.
There are also concerns over Trump's attempts to influence the Federal Reserve, which could impact the status of the dollar. The president has long criticised Powell for not lowering interest rates, and has threatened to fire and replace him.
Earlier this month, US Secretary of the Treasury Scott Bessent told Bloomberg that the White House has begun the formal process of finding a successor for Powell, whose term ends in 2026. This comes amid reporting from CBS News that last week, the president asked a group of Republican lawmakers if he should fire Powell.
However, Trump told reporters later that firing Powell was 'highly unlikely'.
'Policies of that nature, which would make investing in US treasuries risky, particularly for foreign investors, I think that would make me a bit more concerned about a loss of reserve currency status,' Michael Pearce, deputy chief economist at Oxford Economics, told Al Jazeera.
'Tariffs and other policies have taken that kind of US exceptionalism off the table at least for this year. We expect the US to be relatively hard-hit by these tariffs compared to the rest of the world. However, when you think of the long-term performance, it's still a relatively dynamic economy,' Pearce added.
Contenders for the global reserve currency
There are groups of nations that are increasingly positioning themselves to take on a larger role in global finance, but none has yet matched the dollar's influence. This means it is unlikely that any currency could replace the dollar as the de facto global reserve currency.
But there are attempts to challenge the US's influence. BRICS nations have moved to reduce their reliance on the US dollar in recent years, which has become a growing concern for Trump.
At the same time, the European Central Bank is also pushing for the euro to play a more central role in the global system, but as Lagarde noted in her essay, a 'step towards greater international prominence for our currency will not happen by default: it must be earned'.
Despite attempts by other nations to expand their influence over the global reserve, and the recent decline in the dollar's value, economists argue that it is unlikely the dollar will lose its status as the world's reserve currency. And, if it did, it might take decades to even see a minor shift.
'It's definitely premature to worry about the dollar losing the global reserve currency status. Even if [it did], that would take multiple years for that to happen,' Hong Cheng, the head of fixed income and currency research at Morningstar, told Al Jazeera.
Pearce also said that a change in the global reserve hierarchy was unlikely.
'A dramatic shift in which the US clearly loses its place atop the pile, I think that's far off the cards. I find it difficult to see any viable contender emerging to the dollar in that sense,' Pearce said.
Instead, experts say a more realistic future could involve a multipolar currency system, where the dollar shares its role with other major currencies, including China's renminbi.
'We could be heading into some kind of multipolar reserve currency environment where there is an additional role for currencies like China's renminbi. There's no one clear alternate currency,' said Ziemba, the adjunct senior fellow at the Center for a New American Security.
Even if a transition were to occur, it would take decades.
'You would need kind of a managed unwinding through either coordination or kind of some sort of alternative system to emerge, which again would take time,' Jacquez said.
While the dollar's share in global reserves has declined, it is not at an unprecedented low.
'The dollar share in FX [foreign exchange] reserves was lower in the early 1990s, so the recent decline in its share is not completely out of the norm to just under 60 percent,' according to JPMorgan Chase.
In emerging markets, 'the same ratio of USD reserves as in 1995' still holds. Even after recent sell-offs, including one by China in April, analysts do not expect a major impact.
Countries often hold US Treasuries as liquid assets, which provides stability to their own currencies, so unravelling the US dollar's status could also undermine their own interests.
'With more than 30 percent of foreign Treasury holdings maturing in the next 2 years, international investors are more likely to let these assets mature and choose to reinvest part of the proceeds elsewhere. We think large-scale selling is unlikely,' the note added.
That signals that the US dollar will likely remain dominant for the foreseeable future.
'I don't think there's one dominant currency that's gonna replace the dollar. And if there was hypothetically a change, I think that's going to take many years to shift,' Cheng added.
'We're talking about the next 20, 30, or even 50 years.'