The US dollar has dominated global financial markets since the end of World War II. Almost 60 percent of global foreign exchange reserves are held in dollars, with the euro a distant second at around 20 percent. Around 90 percent of transactions in foreign exchange markets are invoiced in dollars, as is half of international trade.
Reinforcing the dollar’s standing is its status as a safe haven currency during times of crisis. For example, during the Great Recession of 2008 and the COVID-induced financial crisis in 2020, investors sought US dollars, expecting them to retain their value through the crises.
The US government, economy, and citizenry reap huge benefits from the dollar’s “exorbitant privilege,” as a former French finance minister called it, in global financial markets. Because of the strong global demand for US dollars and dollar-backed securities such as US treasury bonds, the United States can borrow at far lower interest rates than other countries.
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The US government and firms are also able to borrow from foreign creditors in dollars rather than foreign currencies, so the value of the debt does not change with fluctuations in exchange rates. A high demand for the dollar also strengthens its value vis-à-vis other currencies, leading to cheaper products for US consumers—although, on the flipside, it also makes US exports less competitive.
The global hegemony of the US dollar also gives the United States government the power to impose far-reaching and effective sanctions on its adversaries, a powerful foreign policy tool. However, despite its continued dominance, domestic and international challenges to the US dollar are mounting.
Ironically, in part because of its extremely low borrowing costs, the US has accumulated a staggeringly high amount of debt, at USD 32.11 trillion, that is unsustainable in the long term and could undermine confidence in the US dollar. Politically, it is difficult for leaders to address the issue of spiraling debt. Though the American public supports reducing debt and spending, specific steps to do so—such as tax increases and reforming entitlement programs like Social Security and Medicare—are unpopular, especially among older Americans.
The ceiling on the amount of debt that the US can legally hold is a more immediate threat. This rather unusual mechanism is a limit not on actual spending, but rather a limit on the Treasury’s ability to borrow to pay off debt it already owes, which cannot be raised without authorization from Congress.
The United States is one of few countries in the world with such a debt ceiling. Breaching the debt ceiling would lead to default. That is why, since it was first instituted in World War I, the debt ceiling has been raised dozens of times by Congress.
However, as demonstrated yet again recently, rising political polarization has made default a real possibility. Whenever the time comes to raise the debt ceiling every few years, one or both parties initiate a game of political brinkmanship to extract concessions from the other side. A default would be catastrophic and could severely undermine confidence in the US dollar and its status as a safe haven.
The credit rating of the US would be downgraded drastically, thus ending the exorbitant privilege of the dollar. Even coming close to it can have consequences. In 2011, Standard and Poor’s downgraded the country’s credit rating when it got two days away from hitting the debt ceiling. More recently, Fitch Ratings did the same, despite the last-minute agreement between President Joe Biden and House Speaker Kevin McCarthy averting a default.
The debt limit does not even help address rising debt, as evidenced by the national debt’s continued growth despite numerous debt ceiling standoffs in recent years.
The dollar’s global hegemony gives the US government power to impose crippling sanctions and wage other forms of financial warfare against adversaries. Since 9/11, it has used this power with increasing frequency.
In 2022, more than 12,000 entities were under sanction by the Treasury Department, a more than 12-fold increase since the turn of the century. US sanctions have not had the best record in changing regimes’ behaviors, but they do ensure that targeted adversaries pay a significant price for continuing to engage in actions it opposes.
Often, their usage is noncontroversial, as in the case of the sanctions on Russia for its invasion of Ukraine. However, if used excessively, they can make countries, including allies, want to move away from the dollar-based financial system. For example, European countries opposed the US’ unilateral withdrawal from the Iran nuclear deal.
However, due to the secondary sanctions, which were a…
Read More: The Future Of Dollar Hegemony | The Reporter