Trump's Presidency and the Dollar's Reserve Status: Why the World Should Look Beyond the Dollar
15th BRICS Summit. Source: Public Domain
By Sumesh Shiwakoty
Introduction
After taking the oath as the 47th President of the United States, Donald Trump repeated his previous warning for BRICS+ nations: If they try "to move away from the dollar" and replace the "mighty dollar" by creating a new BRICS currency or backing any other currency, BRICS nations will face 100 percent tariffs and will be restricted from the U.S. market. [1]
Trump's paranoia that his return to the White House might see a nosedive in the dollar's reserve status stems from his déjà vu. After he took the helm of the U.S. executive branch in 2017, the dollar's global reserve status hit the lowest since 2013. [2] IMF data on the Currency Composition of Foreign Exchange Reserves (COFER) showed that the dollar accounted for only 62.7 percent of global reserves in the fourth quarter of 2017 [3] after rising during the 2016 October–December period to almost 64 percent of the global reserves. [4] The dollar's reserve status never recovered during Trump's first term—it slipped to 59 percent during the fourth quarter of 2020, the lowest it had been in 25 years. [5]
Trump's obsession with preserving the dollar's international role transcends all his other foreign policy goals because the dollar's international status lies at the heart of his "America First" doctrine. The U.S. dollar's position as a global reserve currency has earned the United States seigniorage income, kept U.S. interest rates low, financed U.S.-led wars, assisted in maintaining U.S. military hegemony, added teeth to U.S. economic sanctions, and helped in buying friends and allies.
How did the dollar become the reserve currency?
It warrants reminding that the dollar gained reserve status in the aftermath of the Second World War not due to chance but because American strategists, having noted Great Britain's financial leverage during the nineteenth century, promoted the dollar as the dominant international currency, shaping the outcome of the Bretton Woods Conference in 1944. [6]
In the aftermath of the Second World War, while many parts of the world, especially Eurasia, were devastated, the United States emerged as a more prosperous and stronger nation than ever before, with unrivaled military superiority. [7] In his book, A Preponderance of Power: National Security, The Truman Administration, and the Cold War, University of Virginia historian Melvyn P. Leffler notes:
"At the end of the Second World War, the United States had two-thirds of the world's gold reserves and three-fourths of its invested capital. More than half of the entire world's manufacturing capacity was located in the United States, and the nation was turning out more than a third of all goods produced around the world. The gross national product of the United States was three times Soviet Russia's and more than five times Great Britain's." [8]
As a result of this "enormously productive economy," Leffler asserts, the United States was able to build up unmatched military superiority. This resulted in assembling an unrivaled strategic air force, the U.S. Navy's dominance over the oceans, and a monopoly over atomic bombs, the most intimidating weapon humankind had ever seen. [9]
Thus, the United States' economic and military superiority bestowed U.S. policymakers with a strong negotiating position in the Bretton Woods Conference. As a result, the United States was able to convince participant countries to tie their currencies to the U.S. dollar, assuring those countries of its stability by linking the dollar to gold at the rate of $35 per ounce. [10] The outcome of Bretton Woods was so consequential that one senior official of the Bank of England at the time marked the adoption of the Bretton Woods framework as "the greatest blow to Britain next to the war," giving the United States what former French Foreign Minister Valery Giscard d'Estaing famously called "exorbitant privilege." [11]
How has the reserve status of the dollar benefited the United States?
This privilege allows the United States to run massive trade deficits, importing more than it exports without suffering detrimental impacts from a negative trade balance, and leading foreign governments to purchase large amounts of U.S. Treasury securities, keeping U.S. interest rates low. [12] UC Berkeley economist Barry Eichengreen argues in his book Exorbitant Privilege that this has enabled American households to live beyond their means at the expense of the rest of the world. [13] A McKinsey Global Institute report estimates that the dollar's reserve currency status has generated net financial benefits of about $40 to $70 billion annually for the United States. [14] Considering the U.S. GDP of $27.7 trillion, the reserve currency status alone has generated more than a quarter of a percentage point of the U.S. GDP. Although this amount seems trivial, this is still a lot when the U.S. GDP grows by approximately 2 percent per year.
Further, the dollar's reserve status has motivated the global use of the dollar as a medium of exchange, creating the dollar's international demand. [15] For instance, it has been estimated that nearly three-fourths of all printed $100 bills circulate outside of the United States' jurisdiction. [16] This allows the U.S. Federal Reserve to simply print more money and ship it outside the United States, essentially exporting inflation away from the U.S. market while generating what economists call seigniorage income. In his book, Eichengreen summarizes the financial benefit of seigniorage income: "It costs only a few cents for the Bureau of Engraving and Printing to produce a $100 bill, but other countries have to pony up $100 of actual goods and services in order to obtain one." [17] Additionally, due to the reserve status, the United States has also been able to borrow in its own currency. [18]
Moreover, the reserve status of the dollar has given teeth to U.S.-led economic sanctions. The dollar remains the preferred currency for invoicing and settling international transactions, even if those goods and services never touch American shores [19], mandating that foreign banks use the American banking system to clear payments and manage cash. [20] This leverage provided by the U.S. dollar has forced U.S. rivals to comply with U.S. demands. For instance, in 2013, after the United States sanctioned North Korea, the Bank of China halted its services to North Korean clients. [21] Further, in 2012, at the height of American pressure on Iran, China was forced to cut imports of Iranian oil. [22] Moreover, currently, India's import of Iranian crude oil is almost nil after the Trump administration decided not to renew the sanction waiver for India. [23] However, before India’s compliance with the sanctions, Iran was one of India's top sources for importing crude oil. [24] Thus, the dollar's international status has given the United States soft powers that have allowed it to contain and punish its rivals and advance the American way of thinking.
The reserve status has also enabled the U.S. government to finance multiple wars through deficit financing, which, as University of Missouri economist Michael Hudson observed, was "something never before accomplished by any nations in history." [25] Today, because the dollar's international role and the U.S. military's global presence are so intertwined, many political scientists and economists would agree that if the dollar loses its international status, the U.S. military's global presence will shrink. [26]
For instance, Dartmouth political scientist Michael Mastanduno points out that during the Vietnam War, President Lyndon B. Johnson "opted for guns and butter—an activist military policy abroad and an ambitious expansion of the welfare state at home—and financed both not by raising taxes but by allowing the expansion of dollar holdings by foreign central banks." [27] In agreement with Mastanduno, Stanford economist Ronald I. McKinnon also maintains that U.S. government military spending for the Vietnam War was not tax-financed but was "accommodated by overly easy money by the U.S. Federal Reserve Bank." [28] During the Vietnam War, U.S. military actions were so synonymous with the U.S. balance of payments problems that the then-Italian Foreign Minister once suggested to his American counterpart that "a prompt end to the Vietnam War would help solve the U.S. balance-of-payments problem." [29] Further, research shows that the U.S. government had financed military actions in Korea, Cambodia, and Laos also through borrowing from other foreign countries. [30]
In the 1980s, President Ronald Reagan also oversaw a military buildup, and studies show that the initiative was also not tax-financed but was sponsored through deficit financing. [31] Similarly, the Bush administration, after the September 11, 2001, attack, decided to increase U.S. defense spending while cutting taxes, and such endeavors became possible because the reserve status allowed the Bush administration to run an external deficit. [32]
Thus, many scholars believe that a diminished dollar role will make it tough for the United States to project a foreign military presence.
Why has dollar hegemony prevailed in the post-Bretton Woods era?
In 1971, when U.S. policymakers realized that other nations held almost three times as many dollars as the United States was capable of redeeming in gold [33] , President Richard Nixon unilaterally killed the Bretton Woods arrangement. [34] However, the dollar-centered monetary system survived, strengthened by the dollar's dominant role in oil markets, thanks to the 1974 agreement between American President Nixon and Saudi King Faisal that compelled Saudi Arabia to accept payments for oil exports in dollars. [35] The essence of the petrodollar is so crucial for the United States that some scholars have argued that many regime change campaigns or wars that the United States undertook were motivated by threats to trade petroleum products in currencies other than the dollar. [36]
After the 2008 financial crisis, there was global discourse that the dollar-based global reserve system contributed to financial instability. [37] The United Nations Commission of Experts on Reforms of the International Monetary and Financial System, chaired by Columbia University Professor Joseph Stiglitz and People's Bank of China Governor Zhou Xiaochuan, advocated for reforms. [38] Yet those proposals never became a reality—partly because of the lack of alternatives and partly due to the sustained macroeconomic stability of the U.S. economy, which promoted international confidence in the dollar. [39]
Ongoing de-dollarization efforts
Today, Trump's return to the White House, his erratic foreign policy, and the weaponization of the dollar are weakening international confidence in the dollar. Recent data from the IMF's COFER indicate that the dollar is losing ground not to other traditional reserve currencies but to what experts call "non-traditional currencies" such as the Chinese renminbi, Singaporean dollar, and the Nordic currencies. [40] Foreign central banks are also stockpiling gold—1,136 metric tons in 2022 alone, the highest level since 1950—to diversify away from the dollar. [41]
BRICS+ nations are actively encouraging oil-exporting countries to trade in a non-dollar environment. In 2023, for the first time, China paid the UAE for natural gas in renminbi instead of dollars, and China and Saudi Arabia signed a currency swap agreement. [42] S&P Global Ratings predicts that deepening economic ties between the world’s largest oil importer, China, and the world’s largest oil exporter, Saudi Arabia, will encourage the use of renminbi for oil purchases. [43] China surpassed the United States as the largest oil importer in 2017 and now holds significant leverage over oil-exporting countries—a reality the West has not yet fully confronted. [44] Moreover, BRICS+ nations’ collective GDP has eclipsed that of the G7 in terms of purchasing power parity, signaling a shift in the global economic center of gravity away from the West. [45]
Future of the reserve arrangement
In recent years, investors such as American billionaire Stanley Druckenmiller have warned that the dollar "could cease to be the predominant global reserve currency within 15 years." [46] Interestingly, studies have suggested that it is less likely that the United States will be willing to pursue policies to meet the implicit responsibilities associated with the dollar's status as a global reserve currency if those policies conflict with the policies needed for domestic growth. [47] No matter how much Trump would like for the dollar to reign in the international monetary order, the benefits of being a reserve currency come with trade-offs, and one trade-off of being a reserve currency is that the reserve status causes the overvaluation of the reserve currency. For instance, in the case of the U.S. dollar, the reserve status has caused the overvaluation of the dollar by around 5 to 10 percent, as per an estimate. [48] This overvaluation of the dollar harms American exports.
One of the reasons why U.S. policymakers seem unwilling to uphold the implicit responsibilities associated with the dollar’s reserve status and their shrinking tolerance for the overvaluation of the dollar is due to the shifts in the U.S. domestic political environment. The recent rise of populist political candidates like Donald Trump and Bernie Sanders confirms that to win political support, one cannot ignore working-class Americans' interests, a majority of whom depend on U.S. exports. Interestingly, research confirms that the U.S. reserve status disproportionately benefits households in the upper half of the income distribution, which leans on higher bank borrowing than working-class Americans. [49]
On the other hand, considering the dollar’s gradual decline as a reserve currency and observing China’s active role in the internationalization of renminbi, one may argue that renminbi might ascend to dominate the global reserve status. However, this is unlikely, at least in the foreseeable future, because renminbi has its own shortcomings too. First and foremost, at present, the renminbi is not fully convertible. [50] Moreover, China's financial markets are not very liquid, and the Chinese capital market is nowhere as developed in comparison to its Western counterparts. [51] Further, economists such as Cornell University's Eswar Prasad argue that the dollar’s strength as pre-eminent global reserve currency “resides in America’s institutions.” [52] He argues that “deep financial markets, a robust legal system, and a generally transparent political process underpin the dollar.” [53] Since China currently lags behind in most of these features, it is unlikely that renminbi will achieve supremacy as a global reserve currency in the near future.
Likewise, the BRICS+ currency is also unlikely to materialize anytime soon, as BRICS+ nations are divided on the topic of common currency issuance. [54] Further, the discourse surrounding the creation of the BRICS currency goes back to the aftermath of the 2008–09 global financial crisis. [55] However, the divergence of individual countries' economic and foreign policy interests has left little room for consensus. [56]
Nevertheless, many analysts in recent days have also floated the idea that the euro should seize the opportunity and should prevail over the dollar. [57] As a matter of fact, the euro has remained a runner-up reserve currency for many years now, with almost 20 percent of the global reserve held in the euro, as per the IMF data. [58]
However, the notion that the euro will supersede the dollar as a reserve currency is simply wishful thinking. First of all, there is little incentive for the euro to challenge the dollar, as the European Union (EU) leans heavily on the U.S. economically and militarily. [59] If the euro were to deliberately compete against the dollar for the reserve status, this would jeopardize the U.S. security umbrella and create other economic externalities, which would be self-defeating for the EU. It is because of Europe's dependence on the U.S. security umbrella and economy that the then U.S. Secretary of the Treasury John Connally once famously reminded his European counterparts that “the dollar is our currency, but your problem.” [60]
Second, there is an economic cost associated with promoting the euro as a reserve currency. The euro’s current reserve status has already caused the overvaluation of the euro, reducing the competitiveness of the EU’s export and the eurozone’s import-competing sectors. [61] There are reports that indicate that some companies are already moving production away from the eurozone area to cushion against the appreciating euro. [62] Since, for the EU, the cost of promoting the euro as a reserve currency far outweighs any potential gain, EU policymakers such as the former European Central Bank president Jean-Claude Trichet have publicly declared, “the euro was not designed as a global reserve currency.” [63]
As the world's two leading reserve currency issuers, the United States and the European Union may discard a leadership role “in terms of policy settings consistent with global exchange rate stability,” mainly to combat unemployment and fuel growth at home. [64] The McKinsey Global Institute report warns that the world may de facto be in a period of an “unmanaged” reserve currency system with no “firm hand on the tiller.” [65]
Nevertheless, from the perspective of the reserve currency issuer, why should they shoulder the burden of setting monetary policies for the entire globe? As Yale economist and former US Under Secretary of Commerce for International Trade, Jeffrey E. Garten writes, “if there is no inflation in the United States, the Fed won't lower interest rates simply because that would help, say, Southeast Asia. Such global responsibility is not in the Fed's charter.” [66]
Towards a post-dollar era
It is true that when it comes to sheer numbers, the dollar, to this date, is still the king. The Federal Reserve Bank of New York website proudly asserts, “The U.S. Treasury market is the deepest and most liquid government securities market in the world.” [67] However, with Trump in the White House, global faith in the U.S. Treasury also seems to be in decline. Since Trump took office, investors abroad have been selling tens of billions of long-term U.S. Treasuries for consecutive months, which an analyst points to as “a sign of central bankers reducing their reliance on the U.S. as a financial buffer.” [68]
Moreover, scholars have argued that the dollar’s dominance hinges not just on the size of the U.S. GDP, stock market, or the U.S. Treasury market but also on the U.S. relationship with the rest of the world, especially its own allies and their reciprocity. For instance, in 1960, when the price of gold was bid up to nearly $41 an ounce in the London gold market [69] , the governments of Western Europe and Japan recognized that this might blow the gold cover of the dollar at $35 per ounce as per the Bretton Woods arrangement. Thus, to drive the price of gold to the U.S. parity, the central banks of Western Europe and Japan, along with other U.S. allies, collaborated closely with the U.S. monetary authorities to create the Gold Pool. Moreover, in 1962, West Germany teamed with the Kennedy administration for a project to recycle dollars back to the United States by agreeing to use surplus dollars to purchase American military equipment. Later, West Germany explicitly pledged to hold surplus dollars rather than turning them back to the United States for gold [70].
However, with Trump in the White House, the U.S. allies’ trust in the U.S. has started to falter. For instance, after the Trump administration decided to halt military and financial support for Ukraine and ambivalence surrounding American commitment to European security, the EU leaders in recent days have sought to become self-reliant for their own security, even without the U.S. security umbrella, by initiating plans such as the €800 billion “ReArm Europe” plan. [71] Moreover, after Trump decided to levy global tariffs, including on imports from many allies such as the EU countries, French President Emmanuel Macron appealed to European companies to halt their planned investment in the U.S. [72] The altercations that the Trump administration is engaging in with its own allies, on whose reciprocity of favor the dollar depends for maintaining its reserve status, is something unprecedented after the Second World War. [73]
Further, many scholars agree that the dollar’s reserve status leans on faith in American institutions and the rule of law. However, Trump is pushing both of these pillars of American democracy to their very edge. For instance, experts worry that the Trump administration’s ongoing efforts to undermine the independence of the Federal Reserve will deteriorate global confidence in the dollar. Moreover, with Trump firing two Democrat members of the Federal Trade Commission, an independent body, and concerns regarding whether foreign investors will be treated fairly in the U.S., it is unclear whether U.S. institutions can uphold the rule of law in the future. If the U.S. could not “uphold the rule of law, respect the separation of powers, and honor the country’s commitments to its foreign partners,” scholars argue, this may further pave a path for the deterioration of the dollar’s reserve status. [74]
In this current situation, President Trump has every reason to be anxious, as any serious initiative by BRICS+ nations to dethrone the dollar or deterioration of global confidence in the dollar might deal a severe blow to the international status of the dollar. Although the widely talked about BRICS+ currency remains a pipe dream at least for now, BRICS+ nations, which share common distrust for American dominance, may still choose to gradually opt out from the U.S.-led financial order by trading in their own local currencies. [75] Nevertheless, it’s long overdue that the world should look beyond the dollar—not to offend Trump, but to maintain global financial stability and construct a more equitable world that emphasizes the global public good rather than safeguarding the interests of any particular nation.
Theoretically, it can be argued that if the U.S. government has employed economic sanctions to promote American interests afforded by the reserve status of its currency, creating a new reserve arrangement and using the soft powers derived from that arrangement can be used for promoting universal principles such as democracy and human rights. Moreover, monetary benefits such as seigniorage income could be used to finance humanity’s common aspirations, such as curing diseases and combating climate change. A UN commission in the past had also proposed similarly by stating that a new global reserve system could be created that “could contribute to global stability, economic strength, and global equity.” [76] What sort of global reserve arrangement may lead humankind to such a world order? This remains a topic for rigorous academic research, policy analysis, and global discourse. As Trump’s return to the White House could be the final nail in the coffin for the dollar’s reserve status, it is time for countries around the world to work together to create a more just and equitable reserve arrangement.
About the author
Sumesh Shiwakoty is a policy analyst and commentator who has worked with organizations such as the Center for Constitutional Rights in New York, has received multiple research grants, including from the Andrew W. Mellon Foundation, has advised various multinational companies, and is also a 2023 Clinton Global Initiative University (CGI U) fellow. His research and analyses have appeared in publications including The Nation, The National Interest, The Diplomat, South China Morning Post, Asia Times, Oxford Human Rights Hub, Claremont Journal of International Relations, Journal of Humanistic Mathematics, The Kathmandu Post, and The Times of India. He holds a bachelor’s degree from Pitzer College, a member of The Claremont Colleges in Claremont, California, and holds a master’s degree from Central European University Department of Legal Studies in Vienna, Austria, while he has spent academic semesters at Bard College, New York, the University of Delhi in India and the University of Adelaide in Australia. This paper is informed by Shiwakoty’s undergraduate thesis, “The Role of the US Dollar in Sustaining the Liberal International Order,” which he submitted to complete his International Relations major at Claremont McKenna College in Claremont, California, under the supervision of Dr. Hilary Appel.
Endnotes
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