Every few years, the economic and financial media run stories prophesying the end of the U.S. dollar’s role as a reserve currency, its replacement with the Chinese renminbi, and the supposed calamities to follow. What the doomsayers miss is that the dollar remains the global reserve currency for now largely due to a lack of convincing alternatives.
There are real economic reasons why the U.S. dollar must, one day, lose its reserve-currency status. Modern interpretations of the “Triffin dilemma” imply that a reserve-currency country that grows smaller relative to the global economy over time will become increasingly stretched in its borrowing. While reserve holdings, like Treasury obligations, are assets from the world’s perspective, from America’s perspective they’re liabilities. To supply them, the United States has to borrow from the world, running what economists call a current-account deficit. To export dollars and dollar assets, American consumers must live beyond their means (importing more than they export) and provide net demand—and thus economic growth—to the world.
If the American economy constitutes a large share of the global economy, these borrowings for the sake of reserve provision won’t affect Americans. But as the American economy has shrunk from almost 40 percent of global GDP in the 1960s to about 24 percent today, the borrowing necessary to supply reserve assets to the globe has become larger as a share of domestic GDP. As the U.S. economy gets smaller relative to everyone else, it will grow increasingly indebted, and run ever-larger trade deficits, to keep supplying reserve assets. That process will drive instability in the U.S. economy—and cause the dollar to lose its attractiveness.
That outcome should happen eventually, but economic eventualities can take a long time to unfold. For example, by the 1960s, economists had generally formed a consensus that the market’s price mechanisms were essential to a functioning economy, and that Communist systems were doomed to collapse. Yet the Soviet Union took decades to implode, and China is still ruled by its Communist Party.
And what could even replace the dollar right now? A reserve currency has two primary functions: as a usable means of trade between two countries, neither of which is the reserve; and as a dependable store of wealth. While the two functions are distinct, one common requirement is that a currency must be “convertible,” or free of capital controls. In other words, economic agents must be able to convert the reserve currency into other currencies at will.
One hypothesized alternative to the dollar is the Chinese renminbi. But it is heavily regulated by the Chinese government and thus lacks convertibility. To make the renminbi convertible, Beijing would have to liberalize capital accounts and cede control over the value of its currency, accepting the volatility of international capital flows. That volatility could in turn disrupt China’s heavily debt-dependent domestic economy, to unknown and potentially cataclysmic effect.
It is also a requirement of a reserve currency that, once a transaction is completed, savers looking for stability must be willing to hold that currency. They must believe that their savings won’t be confiscated by the issuing country, whether overtly or via inflation. Confidence in the rule of law is paramount. Even if countries are willing to receive yuan from China in exchange for their exports, scant evidence exists to suggest that they’re willing to keep those yuan invested in Chinese government bonds instead of exchanging them for dollar assets.
The euro is another alternative. But Europe’s share of global output has been shrinking even faster than America’s, so its reserve attractiveness should decline faster, too. Further, the European bond market is fragmented into smaller, less liquid bond markets, and still lacks institutional clarity on just how risk-free the bonds are, given the European Central Bank’s political dance around the conditions under which it will back them. For these reasons, Europe has struggled to expand its share of international reserves.
To export reserve assets continually, a country must borrow from the rest of the world and import more than it exports. In the case of countries with export-driven growth dependencies, like China or Germany, the scale of necessary imports would require a major overhaul of the economic model. For political purposes, most countries prefer to take demand from the world rather than provide it. And for countries with big debt problems, like China, allowing the rest of the world to be the marginal lender setting the price for new borrowing would entail enormous risk.
So far, then, no alternative exists to the dollar. No other country has been willing and able to import more than it exports; provide a unified, deep, and liquid market with crystal-clear institutional rules; and convince savers that it won’t confiscate their holdings via inflation or other means. As a result, the dollar’s share of reserve assets has remained relatively stable at 60 percent since the 2008 financial crisis, with fluctuations driven mostly by changes in valuation. While the renminbi slowly climbed to a peak of nearly 3 percent of official reserves, its share has declined for the last few years. Similarly, over 88 percent of all currency transactions included the dollar on one side in 2022, up from 85 percent in 2010.
Losing reserve status would be double-edged for the U.S. The most commonly ascribed benefit of having the reserve currency is what the French politician Valéry Giscard d’Estaing famously called the “exorbitant privilege” of running persistent international deficits without risking crises in currency or bond markets. But other advanced economies—including Australia, Canada, and the United Kingdom—have histories of running persistent international deficits combined with lower interest rates than America’s, yet don’t suffer from currency crises.
Contrariwise, supplying the reserve currency to a growing world has also proved an exorbitant burden. The reserve demand for dollars results in a currency persistently too strong for domestic industry to remain internationally competitive. In our own version of the “Dutch disease,” Americans, endowed with the rule of law and a large liquid market, have exported financial assets in such a way as to hollow out significant portions of the real economy. The dollar might be fairly valued from models of international finance due to the reserve demand for our debt, but it has clearly traded at levels far too high to balance international trade. The result: a domestic manufacturing sector that is a shadow of its former self and socioeconomic blight across former manufacturing hubs.
Over the past two decades, official total reserves have grown from $3 trillion to about $12 trillion, roughly 60 percent of which are denominated in dollars. Anyone who believes that bond purchases by the Federal Reserve affect markets and the economy must concede that purchases by other governments do, too. The persistent trade deficits plaguing our manufacturing sector, and thus increasing our vulnerability to shocks and social upheaval, fall out of the Triffin mechanism—importing goods has been the mirror image of exporting reserve assets.
The real disadvantage of losing reserve status would be geopolitical. Namely, the U.S. would no longer have the ability to project power globally via the financial system. In the last two decades, the nation’s security apparatus has pursued increasingly extraterritorial financial policy via primary and secondary sanctions, restrictions on SWIFT payment-processing access, demands for financial records from other nations, and asset seizures. Sometimes these actions are taken in defense of the American homeland against terrorist organizations and states, such as Iran; sometimes they are taken in defense of other nations, such as Ukraine; and sometimes they are taken for foreign policy reasons, such as punishing human-rights violators. One might worry that the more the U.S. uses these tools, the more it undermines the dollar’s reserve status: consider that Russia and China are increasingly motivated to find ways around the dollar. In any case, this serious risk lies somewhat beyond the purview of economic evaluation.
Until another nation develops an alternative that is a trustworthy means of international exchange and a store of value for large pools of capital, America’s reserve currency is “as sound as a dollar.” Stories to the contrary make good fodder for the news cycle but aren’t likely to lead to meaningful consequences for the American economy.