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Is the dollar domain about to fade? Donald Trump insists that “if we lost the dollar as world currency … that would be the equivalent of losing a war.” However, he could be the cause of such loss. The dependence on a foreign currency depends on confidence in its own strength and liquidity. Trust in the dollar has eroded slowly for a while. Now, Bajo Trump, the United States has become erratic, indifferent and even hostile: why would one trust a country that has launched a commercial war against allies?
However, although strangers can desire to diversify away from the dollar, they lack a convincing alternative. So what, in any case, could replace your hegemony?
The dollar has been the world leading currency for a century. However, the dollar itself replaced the sterling pound after World War I, since the power and richness of the United Kingdom decreased. Objectively, the United States is not decreasing since the United Kingdom was at that time: according to the IMF, its participation in the nominal world GDP was 26 % in 2024, against 25 percent in 1980. Given the emergence of China’s economy during that period, this is remarkable. The United States also remains on the border of world technological development and the greatest military power. Its financial markets remain much deeper and more liquid. In addition, in the fourth quarter of last year, 58 percent of world reserves were in dollars, below 71 percent in the first quarter of 1999, but far ahead of 20 percent of the euro. According to Macromicro, 81 percent of commercial finances, 48 ​​percent of international bonds and 47 percent of cross -border bank claims are still in dollars.
So what could go wrong? In his work in the international system, Charles Kindleberger argued that the stability of an open world economy depended on the existence of a hegemonic power arranged and capable of providing essential public goods: open markets for commerce; stable money; and a lender of the last resort in a crisis. The British provided all three to 1914. The United States should do so after 1945. But in that intermediate period, the United Kingdom could not, and the United States would not provide these goods. The result was calamito.
The era of dollar hegemony has seen many clashes. The recovery of the postwar period of Europe and Japan undermined the fixed exchange rate system agreed in 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 the creation of the European exchange rate mechanism and then to the euro. While economists tended to think that foreign exchange reserves would cease to be important in a world of floating rates, a large amount of financial and monetary crises, especially the Asian crisis of the end of the 1990s, showed the opposite. Loans of the Federal Reserve were also tested of continuous importance, especially in the financial crisis of 2008-09.
Kindleberger’s conditions, in summary, are still relevant. The broadest point in which the externalities of the network supports the appearance and sustainability of the dominant global coins, since all users benefit from using the same currency as others and will continue to do so, if they can. But what happens if the Hegemon uses all the economic sticks that may, including financial sanctions, to get yours? What happens if the Hegemon threatens the invasions of friendly countries and encourages the invasions of friendly countries for despots? What happens if the Hegemon undermines its own fiscal and monetary stability and the institutional foundations of its economic success? What happens if your leader is a thug without principles?
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Then, both countries and individuals will consider alternatives. The difficulty is that, however dissatisfactory hegemon is, the alternatives look worse. The Renminbi could be the best currency to use in commerce with China. But China has capital controls and markets for national capital. These, in addition, reflect the strategic priority of the Chinese Communist Party, which is the control, both economic and political. China also seems very likely to use economic coercion. Therefore, China cannot offer the liquid and safe assets that the United States has historically provided.
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The euro does not suffer from these disadvantages of Renminbi. So, couldn’t it replace the dollar, at least in part, as Hélène King of the London Business School argues? Yes, I could do it. But it also suffers from defects. The Eurozone is fragmented, because it is not a political union, but rather a club of sovereign states. This political fragmentation is also shown in financial and economic fragmentation, which limits innovation and growth. Above all, the EU is not a hegemonic power. Its attractiveness can overcome that of the USA at its worst, but it is not rival for the United States at its best.
Then we stay with a competition between three alternatives, with some other options, a global currency or a cryptography based, surely inconceivable. The first option would be the transformation of China or the EUROZONA, so the appearance of one of them as the issuer of a hegemonic currency. The second would be a world with two or three competing currencies, each dominant in different regions. But the effects of the network would create unstable balances in that world, since people rush from one currency to another. This would be more like the 1920s and 1930s than anything since then. The third would be continuous domination by the dollar.
What kind of hegemony in dollars could this be? Ideally, an USA would resurface. But this is increasingly unlikely, given the damage that is now done at home and abroad. In the kingdom of the blind, the one -eyed man is the king. Similarly, even a defective title currency could 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.
Martin.wolf@ft.com
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