Exorbitant Privilege: Why the Dollar Still Reigns Despite Headwinds

Between mid-January this year, when the US Congressional Budget Office called out US public debt as rising from 100% of GDP in 2025 to 107% by 2029 (surpassing the record set just after World War II) and to 118% by 2035, and mid-May, when Moody’s downgraded the US’s sovereign rating from Aaa to Aa1, joining other raters in similar actions, a debate about the demise of the US dollar’s dominance has risen to a din. In the event, US financial markets reacted tepidly to Moody’s downgrade. Investors sold government bonds, with the yield on the 30-year paper briefly rising above 5% and on the 10-year note to 4.47%. Soon, however, markets reposed into uneasy serendipity. The 30-year yield eased below 5%, the 10-year to 4.54% by May 21, and stocks ended successive trading sessions on higher notes. There was just too much else to focus on, with the ongoing tariff tirade ‘Trumped’ up and down and up, and the much-awaited tax cuts in the big beautiful bill taking shape in Congress. By July-end, the 30-year yield fell to 4.84% and the 10-year to 4.35%. Even the 2-year yield, which had topped 4% at the time of the downgrade, has eased to 3.93%. 

Dollar Dynamics 
The US dollar has depreciated, which is the main objective of the tariff tantrum, by 9.4% from its recent peak in mid-January in terms of the DXY index, which is a measure of the US dollar against a basket of six major currencies: the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and the Swiss franc. 

Engineered depreciations of the US dollar have occurred in the past and each one has been as unruly as the one currently underway—the suspension of convertibility in 1971, effectively the default of the US; the Plaza Accord of 1985, which had to be followed up by the Louvre Accord of 1987 to stem an engineering gone too far.

But, does the dollar’s recent moves portend a decline in its eminence on the world stage? Hardly so, simply because there is no rival to the throne yet. The economist Kenneth Rogoff explains in his latest book Our Dollar Your Problem why in turn the Soviet rouble, the Japanese yen, the euro and the Chinese renminbi were all speculated upon as potential rivals but have so far failed to topple the mighty dollar. Although the dollar’s share in global foreign exchange reserves may have fallen from 71% in 1999 when the euro was launched to less than 60% currently, it is still involved in nearly 90% of global foreign exchange market transactions. More than half of all international trade and the lion’s share of international financial transactions, including between non-US countries, is invoiced in US dollars. This global preference for the US dollar was described as “exorbitant privilege” by the former French president Valery d’Estaing. This means that foreign central banks can buy US treasuries as safe assets paying a premium for safety, while US investors buy relatively risky assets from the rest of the world and earn excess returns. The economist Helene Rey estimates this exorbitant privilege at 1.5 percentage points in real terms annually since the 1950s on the US net international investment position. To that extent, the sustainability of US public debt is enhanced.

The dollar’s dominance is likely to remain for the foreseeable future. It is backed by an economy that accounts for over a quarter of global GDP while being more innovative and entrepreneurial than all peers. US financial markets are the deepest, most liquid and the most open in the world. A strong investor protection architecture applies to residents and non-residents alike. These attributes create ‘network externalities’—its dominance is hard wired and perpetuated by its widespread adoption in a self-reinforcing cycle, with inertia among users in switching to any other currency due to associated costs and risks. Moreover, its strength and resilience allows the US to run large current account and fiscal deficits, which translates into a perennial source of dollars to the rest of the world— nearly half of all US dollars issued are held overseas, including 75% of 100 dollar notes. 

Then why do the Cassandras cry au contraire? Perhaps the foremost reason is the second coming of the Trump administration. The institutional architecture of dollar hegemony was assiduously shaped by at least two individuals. Paul Warburg, a founding member of the Federal Reserve Board, was instrumental in the phenomenal growth of the dollar trade acceptance market in the early 1900s. The other was Harry Dexter White who parried with the British interlocutor John Maynard Keynes and laid out the blueprint of the post-World War II Bretton Woods system. It established the dollar as the sun around which all other elements of the international monetary system revolve. Now, however, it is the tariffs, the weaponisation of finance through sanctions, the undermining of relationships with traditional allies, and the deteriorating US fiscal outlook that will shape the fortunes of the dollar. Political dysfunction may potentially accelerate the demise of the dollar in a malign scenario when all of the above operate in concert—the stealth erosion of dollar dominance, according to the economist Barry Eichengreen.  

Policy Fallout 
The parlous US fiscal situation is a major reason seen for the dollar’s downfall. The earlier machinations—reneging on gold convertibility or inflating away the debt burden— are not available now. Foreign holders of US debt securities, especially central banks, seem to be the most hapless fall guys this time. US Treasury Secretary Scott Bessent has reportedly mulled the possibility of converting 5- and 10-year treasury bonds held by foreign investors into 100-year bonds bearing low interest rates, whether the investors like it or not. During the 2024 presidential campaign, advisers to Trump such as Robert Lighthizer mooted the possibility of taxing foreign purchases of US treasuries as a way of driving down the US dollar. Trump’s nominee to his council of economic advisers Stephen Miran proposed applying a user fee on foreign official holders of US treasury securities by withholding a portion of their interest payments. It is in these muscular Mar-a-Lago strategies that people see the dollar’s depreciation sliding into the dollar’s decline. Rebuilding the international order with these coercive strategies would be costly, and ultimately counterproductive as it would dislodge the foundation stone of its status as an international reserve currency. Safe assets are safe when everyone thinks they are safe. It is in this context that the stock of US public debt has been referred to as the “Achilles heel” of the dollar by Rogoff.

The Trump administration’s embrace of cryptocurrencies, resistance to oversight of crypto-related platforms and executive order banning the issue or promotion of CBDCs is believed by some to be risking isolating the US from advances in global payment infrastructure. Countries promoting CBDCs are in the crosshairs—China’s renminbi-dominated cross-border international payments systems and India’s e-rupee. The Trump administration’s GENIUS Act signed into law on July 18 may, however, tilt the balance of arguments. By creating a regulatory environment for stablecoins backed by the US dollar/short-term US treasuries, it seeks to enhance the attractiveness of the US dollar’s reserve currency status and cement the position of the US as the leader of the global digital cryptocurrency mania. Consumer protection, bankruptcy processes, anti-money laundering and prevention of illicit digital use are intended to reinforce confidence. Independent research suggests that the move will drive up the demand for US debt, lower interest rates and tamp down yields. And never mind the Cassandras’ shrieks of collateral damage to the rest of the financial system, including disintermediation of resources from the banking system, bouts of huge volatility and fire sales, opacity, and providing a conduit for increasing trade in other cryptocurrencies. For Americans after all, as Rogoff titled his book and as Nixon’s Treasury Secretary John Connally famously remarked, it is “our currency, your problem!”

The story of the rise and fall of currencies is synchronous with the rise and fall of nations. This is the lesson of history, from the silver drachma issued by ancient Athens in the fifth century BC, right up to the First World War in 1914 AD when the pound sterling surrendered to the US dollar. Not by economic power or by technological advantage alone but by military might will a country challenge the ruling global hegemon, displace it, stamp its own authority on the global monetary system and establish its currency as the dominant numeraire of all international stocks and flows. So far, America’s Darth Vader, the iconic antagonist of the Star Wars franchise, has not been sighted. Or has the Dark Knight risen, incognito in shining armour?

Watch this space. 

Click here to read Gold Reserves Surge in Challenge to Dollar’s “Exorbitant Privilege”