Dollar's Reign Challenged: Debt and Sanctions Erode Dominance

Key Takeaway

• The US dollar's dominance is threatened by rising government debt, political dysfunction, and the aggressive use of financial sanctions.
• From 2001 to now, the dollar's share of global foreign exchange reserves dropped from 73% to 59%, with some nations shifting to other currencies for trade.
• Both Trump and Biden administrations have influenced the dollar's value through policies and rhetoric, impacting its global standing.

The Dollar's Dominance Under Threat

The US dollar's position as the world's dominant currency is facing unprecedented challenges. From the aggressive use of financial sanctions to the unchecked rise in government debt and the dysfunctionality of policymaking in Washington, the greenback's supremacy is being questioned. Eswar Prasad, a Cornell University professor and senior fellow at the Brookings Institution, highlights these factors as contributing to the perception that the US dollar's dominance should be under threat. The greenback's share of global foreign exchange reserves has dropped from 73% to 59% since 2001, according to the International Monetary Fund, signaling a shift in global financial dynamics.

The Weaponization of the Dollar

The US has expanded the use of economic sanctions since 2001, leveraging the dollar's global standing to exert political pressure. This strategy has led to a de-dollarization trend, with strategic rivals like China and Russia seeking to reduce their reliance on the greenback, and even some US allies considering alternatives to avoid potential sanctions. The historic freezing of $640 billion in Russia’s central bank assets abroad following the invasion of Ukraine marked a significant point in the dollar's weaponization, prompting governments worldwide to reconsider their dependence on the US currency.

America's Economic Policy Shifts

The US economic policy has seen a dramatic shift from the strong dollar policy of the Clinton era to the inward-looking approach under Donald Trump, who actively sought to weaken the dollar to benefit American manufacturers. This shift continued under President Joe Biden, who maintained Trump's tariffs while focusing on policies like “friendshoring” and “Buy America.” These changes, coupled with the Federal Reserve's interest rate hikes to tame inflation, have contributed to the dollar's appreciation against other major currencies during Biden's presidency.

The Looming Debt Crisis

The US is grappling with a growing national debt, which has surged to $33 trillion, with the cost of servicing this debt now exceeding the annual outlay for national defense. This financial burden, exacerbated by political dysfunction and the inability to manage the country's finances effectively, poses a significant threat to the US economy and the dollar's global standing. The debt-to-GDP ratio, which spiked to 120% following the coronavirus pandemic, underscores the urgency of addressing America's fiscal challenges to preserve its economic leadership and the dollar's dominance.

Street Views

• Eswar Prasad, Cornell University and Brookings Institution (Neutral on the US dollar):

  "The unchecked rise in government debt, the dysfunctionality of policymaking in Washington and the weaponization of the dollar through the aggressive use of financial sanctions have all contributed to the perception that the US dollar’s dominance should be under threat."

• Timothy Geithner, former Treasury Secretary (Neutral on US economic leadership):

  "The thing about the US over the next decade or so is how skillfully we navigate this big change in relative power."

• Mark Sobel, retired Treasury Department veteran (Bearish on US international economic leadership):

  "Odds seem stacked against the US exercising robust international economic leadership."