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Is the dominance of the dollar about to fade away? Donald Trump insists that “if we lost the dollar as the world currency . . . that would be the equivalent of losing a war”. Yet he himself could be the cause of such a loss. Reliance on a foreign currency depends on trust in its own soundness and liquidity. Trust in the dollar has been slowly eroding for a while. Now, under Trump, the US has become erratic, indifferent and even hostile: why would one trust a country that has launched a trade war on allies?
Yet, while outsiders might wish to diversify away from the dollar, they lack a compelling alternative. So, what, if anything, might replace its hegemony?
The dollar has been the world’s leading currency for a century. Yet the dollar itself replaced the pound sterling after the first world war, as the UK’s power and wealth declined. Objectively, the US is not declining as the UK was at that time: according to the IMF, its share in nominal global GDP was 26 per cent in 2024, against 25 per cent in 1980. Given the rise of China’s economy during that period, this is remarkable. The US also remains at the frontier of world technological development and the foremost military power. Its financial markets are still much the deepest and most liquid. Moreover, in the fourth quarter of last year, 58 per cent of global reserves were in dollars, down from 71 per cent in the first quarter of 1999, but far ahead of the euro’s 20 per cent. According to MacroMicro, 81 per cent of trade finance, 48 per cent of international bonds and 47 per cent of cross-border banking claims are still in dollars.
So what could go wrong? In his work on the international system, Charles Kindleberger argued that the stability of an open world economy depended on the existence of a hegemonic power willing and able to provide essential public goods: open markets for trade; a stable money; and a lender of last resort in a crisis. The British provided all three up to 1914. The US was to do so after 1945. But in that intervening period the UK could not — and the US would not — provide these goods. The result was calamitous.
The era of dollar hegemony has seen many shocks. The postwar recovery of Europe and Japan undermined the fixed exchange rate system agreed at Bretton Woods in 1944. In 1971, Richard Nixon, the president most similar to Trump, devalued the dollar. This, in turn, led to high inflation, which ended only in the 1980s. It also led to floating exchange rates and creation of the European exchange rate mechanism and then the euro. While economists tended to think that currency reserves would cease to be important in a world of floating rates, a plethora of financial and currency crises, above all the Asian crisis of the late 1990s, showed the opposite. Loads from the Federal Reserve also proved of continuing importance, notably in the financial crisis of 2008-09.
The Kindleberger conditions are, in short, still relevant. Also relevant is the broader point that network externalities support the emergence and sustainability of dominant global currencies, since all users benefit from using the same currency as others and will continue to do so, if they can. But what if the hegemon uses every economic stick it can, including financial sanctions, to get its way? What if the hegemon threatens invasions of friendly countries and encourages invasions of friendly countries by despots? What if the hegemon undermines its own fiscal and monetary stability and the institutional foundations of its economic success? What if its leader is an unprincipled bully?
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Then both countries and individuals will consider alternatives. The difficulty is that, however unsatisfactory the hegemon might be, the alternatives look worse. The renminbi might be the best currency to use in trading with China. But China has capital controls and illiquid domestic capital markets. These, moreover, reflect the strategic priority of the Chinese Communist party, which is in control, both economic and political. China seems quite likely to use economic coercion, too. So, China cannot offer the liquid and safe assets that the US has historically provided.
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The euro does not suffer from these handicaps of the renminbi. So, might it not replace the dollar, at least in part, as Hélène Rey of the London Business School argues? Yes, it might. But it too suffers from defects. The Eurozone is fragmented, because it is not a political union, but rather a club of sovereign states. This political fragmentation also shows in financial and economic fragmentation, which constrains innovation and growth. Above all, the EU is not a hegemonic power. Its appeal may surpass that of the US at its current worst, but it is no match for the US at its best.
We are left then with a competition between three alternatives, with some other options — a global currency or a crypto-based world — surely inconceivable. The first option would be transformation of China or the Eurozone and so the emergence of one of them as issuer of a hegemonic currency. The second would be a world with two or three competing currencies, each dominant in different regions. But network effects would create unstable equilibria in such a world, as people rush from one currency to another. This would be more like the 1920s and 1930s than anything since then. The third would be continued domination by the dollar.
What sort of dollar hegemony might this be? Ideally, a trustworthy US would re-emerge. But this is ever more unlikely, given the damage now being done at home and abroad. In the kingdom of the blind, the one-eyed man is king. Similarly, even a defective incumbent currency might continue to rule the monetary world, given the lack of high-quality substitutes. Trump would like this world. Most of the rest of us would not.
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