The Paradox Of Dollar Dominance

The Paradox of Dollar Dominance

How Technology Is—and Isn’t—Changing the Global Economy

Gordon Liao, Eswar Prasad, and Tony Zhang

November 12, 2026

• More by Gordon Liao
• More by Eswar Prasad
• More by Tony Zhang

Listen Subscribe to unlock this feature or Sign in.

&
Download

Print Subscribe to unlock this feature or Sign in.

Sign in and to read later

Close

Article link: https://www.foreignaffairs.com/economics/paradox-dollar-dominancehttps://www.foreignaffairs.com/economics/paradox-dollar-dominance

Copy

It is no secret that much of the world is eager to escape from the clutches of the dollar-dominated global financial system. For over a century, that system has given the United States enormous financial clout, which it has wielded in applying financial sanctions against its adversaries and, in recent decades, to borrow money to fund its budget and trade deficits. For decades, foreign governments have tried to weaken the dollar’s grip, but they have had little success in establishing their currencies as a legitimate alternative.

Now, a new force has emerged that could shake things up: technology. Financial innovations, especially in digital currencies and electronic payment systems, could finally give other currencies a better chance of competing with the dollar. These innovations are making it easier and cheaper to exchange currencies directly for one another rather than using the dollar as an intermediary currency.

But for all the new opportunities these innovations create for currency exchange, reduced frictions in global transactions might only reinforce the dollar’s dominance. Even if costs decrease for using dollar alternatives, foreign investors will not capitalize on them if those countries’ financial markets remain unsteady and their institutions weak. As U.S. government debt soars, the country’s rule of law erodes, and the Federal Reserve’s independence comes into question, the dollar’s dominance may seem uncertain. But the dollar could remain supreme by default.

Continued dollar dominance could lead to further global economic turmoil, as the United States antagonizes its trading partners and persists with undisciplined policies that result in large budget deficits and trade deficits. There is a chance that the dollar, too, loses the trust of foreign investors—a prospect of comeuppance that would no doubt be received with glee in many capitals. But governments should be careful what they wish for. A world bereft of a reliable currency of last resort at times of global financial panic could be even more unstable than one dominated by Washington.

CATCH ME IF YOU CAN

The U.S. dollar should be losing its dominance in global finance for a host of reasons. First is the country’s penchant for weaponizing its currency. Across administrations, Washington has imposed financial sanctions on rivals, such as Iran and Russia, cutting off their access to dollar transactions and thereby kneecapping their foreign trade. The economies of U.S. allies sometimes get tangled up in these sanctions, too, when the U.S. government threatens to use secondary sanctions to cut off their banks and corporations from access to dollars in order to deter third parties from transacting with the sanctioned countries. In 2014, for instance, U.S. authorities penalized the French bank BNP Paribas for processing dollar payments on behalf of clients in Cuba, Iran, and Sudan. The French government protested the fine to no avail. In light of such heavy-handed behavior, government officials and central bankers outside the United States have hardly been shy about their intentions to reduce their dollar dependence.

Washington’s broader policy choices, especially the lack of fiscal discipline, should also be undermining confidence in American financial markets. U.S. federal government debt now exceeds $40 trillion, nearly 125 percent of the country’s annual GDP, and there are scant signs that Washington is trying to rein it in. Such high debt levels usually lead to some combination of high inflation, soaring interest expenditures, and currency depreciation. The Trump administration’s hostile approach to international trade, including with close allies, is also causing governments to consider “de-risking” their economic ties to the United States. President Donald Trump’s open attacks on the independence of the Federal Reserve and weakening of checks and balances are eroding the pillars of the U.S. institutional system that underlies foreign investors’ trust in the dollar.

The dollar’s most discussed putative rival has faded.

And indeed, there are some signs of the dollar’s decline. The currency’s of foreign exchange reserves held by foreign central banks has fallen from 71 percent in 2000 to 57 percent today. Yields on U.S. Treasury securities—the asset long seen as the ultimate safe haven for investors during financial turmoil—have risen, meaning investors are demanding a higher return for lending to the U.S. government. In October, the yield on ten-year Treasury notes hit 5.3 percent, the highest level since 2002.

In most other dimensions, however, the dollar looks as dominant as ever. Sixty percent of cross-border transactions are denominated in dollars when excluding the eurozone, which is defined by the common use of the euro, and that number has only gone up in recent years. The euro’s of cross-border payments outside the eurozone now stands at about 13 percent, and the renminbi’s is less than three percent. The dollar remains preeminent in most other measures of a currency’s international usage, too, including its of trading activity in foreign exchange markets and denomination of international debt securities, which corporations use to raise funds in global capital markets.

In short, no serious rivals to the dollar have emerged. The reason is simple: other major currencies look even shakier than the dollar. Traditional reserve currencies such as the euro, the yen, and the pound sterling have been undermined by their countries’ weak economies and political instability. Although currencies such as the Australian and Canadian dollars, the Swedish krona, and the Swiss franc have filled in some of the gap, each of these is too small to be consequential in global finance. The dollar’s most discussed putative rival, the renminbi, has also faded. Beijing has done little to alleviate the Chinese economy’s deep-rooted problems, including a prolonged property market slump, high levels of local government debt, and tight government control over the economy and financial markets. Moreover, the Chinese government has been unwilling to allow for the free flow of money across its borders or for market forces to determine its currency’s exchange rate. The renminbi has, in turn, failed to garner greater international use. The result is a second tier of currencies that is increasingly fragmented, with none able to pose any real challenge to the reigning currency hegemon.

TWO SIDES OF THE SAME COIN

In the era of modern financial markets, one of the main purposes of an international currency has been to facilitate indirect transactions among different currencies. It has long been easier and cheaper for a Chinese importer of Brazilian iron ore to exchange renminbi for dollars and pay for the ore in dollars and for the Brazilian exporter to then convert those dollars into Brazilian reais. This is because cross-border payments have long been dominated by a dollar-based global banking network, making dollars the most plentiful currency to conduct payments with. But in recent years, digital technologies have created cheaper and quicker pathways for moving money across borders.

One critical innovation has been the tokenization of money and financial assets, which has been facilitated by technology called blockchain. Blockchain, essentially a public digital ledger that is managed by a computer algorithm rather than by a single bank or clearinghouse, offers a platform for tokenized assets to trade. It does not matter which country the parties are located in, as long as they have Internet access. In the last few years, tokenization has expanded to include not just cash but also financial assets such as government bonds, equities, and mutual funds.

In theory, these changes have the potential to reshuffle the international currency order. Over the past few years, countries such as Brazil, China, India, and Russia have been conducting more trade in their own currencies by building their own cross-border payment networks and linking them to one another, in an effort to reduce their reliance on the dollar. The quantity of these transactions is still modest, because the currencies have limited use outside their countries, and it is still easier and cheaper to transact in a well-recognized and widely accepted currency such as the dollar. But as the countries’ payment systems and financial markets develop further, that number could increase dramatically, altering the currency landscape. Blockchain-based financial innovations could add momentum.

Dollar-denominated stablecoins are a boon for the United States.

Cross-border investment could become much easier, too. Currently, investing in foreign securities involves going through brokers and other middlemen who demand hefty fees and take days to process transactions. But the tokenization of bonds and equities has expanded investors’ access to a broader swath of international financial assets, even in emerging-market and developing economies, where financial markets tend to be small, thinly traded, and not well connected to global trading networks. In the same way, it has expanded the access of entrepreneurs and small businesses to global pools of capital previously out of their reach, which could particularly help businesses in countries with underdeveloped financial markets. Bank deposits are ly to be available in tokenized form soon, too, which will make it easier to conduct transactions through more traditional payment channels.

But the spread of tokenization might strengthen the dollar’s dominance rather than weaken it. The example of stablecoins illustrates this paradox. Whereas cryptocurrencies such as Bitcoin are created and distributed by a computer algorithm, meaning they have nothing anchoring their value, the value of a stablecoin is typically pegged to an official currency. This value is stable because it is backed one to one by stores of safe and liquid assets—usually government bonds, bank deposits, and cash. Those assets are usually denominated in the dollar. More than $250 billion in stablecoins is now in circulation, and over 99 percent of that value is tied to the dollar. As long as the dollar remains preeminent, investors will have little incentive to back stablecoins with any other currency.

Dollar-denominated stablecoins are a boon for the United States. By solidifying the dollar’s central position in international payments, rising demand for dollar-backed stablecoins also indirectly fuels demand for Treasury securities, lowering the yields the U.S. government has to offer investors to buy those securities and making it easier to fund U.S. budget deficits. Other payment innovations could make it even cheaper to use the dollar for cross-border transactions, minimizing the relative advantage that such innovations provide other currencies. Financial innovations built on new technologies cannot by themselves make up for other currencies’ existing weaknesses—namely, the weak economies and institutions that back them up.

COUNTER CURRENTS

There is another major shift underway in the global economy that favors the dollar’s fortunes and that financial innovations are ly only to reinforce. In the first two decades of this century, central banks—particularly those of large emerging-market economies such as China and India—acquired vast troves of foreign assets denominated in hard currencies such as the euro, pound sterling, Japanese yen, and, most of all, the dollar to increase their foreign exchange reserves. These reserves helped those central banks cope with volatility in capital flows and exchange rates, which is a recurring hazard for countries that fall in and out of favor with foreign investors—often because of factors beyond their control, such as changes in U.S. interest rates. But in the last few years, central banks have stopped adding to their reserve stockpiles or have begun diversifying into other assets, such as gold, because they are reluctant to increase their investments in a country with fickle economic and geopolitical policies. In 2010, foreign central banks accounted for 70 percent of U.S. Treasuries held by foreign investors, a that has dropped to about 40 percent as demand has leveled off. The retreat of these once reliable sources of demand threatens Washington’s ability to borrow cheaply.

Luckily for the United States, there is an alternative force that is more than making up for this loss in demand. As the costs to cross-border asset trade fall because of financial innovations, private investors from both advanced and emerging-market countries are increasing their foreign investments in search of higher returns and to diversify their portfolios. And they are flocking to dollar assets, from Treasuries to corporate bonds to equities, because U.S. financial markets offer an unmatched combination of good returns, low trading costs, and legal protections. In the present decade, net inflows of financial capital into the United States have been positive for practically every quarter. Despite chatter about de-risking and diversification since Trump’s election, these inflows have only ramped up in recent years.

Greater financial innovation will intensify rather than reverse these trends, delivering yet another blow to countries seeking to strengthen their currencies and counter dollar weaponization. These trends may hurt small and institutionally weak countries most of all. Those around the world who have long trusted the dollar more than their own currencies now have easier access to it—and they are ly to use it. Increased use of dollar-backed payment systems and investments in dollar assets could cause those countries to cede their monetary sovereignty, weakening their central banks’ ability to steer domestic interest rates and inflation. This phenomenon of “dollarization” has long been rampant in parts of Latin America, which have suffered repeated bouts of high inflation and which, through trade, tourism, and remittances from emigrants, have ready access to dollar cash. Financial innovation could also spread that phenomenon to other corners of the developing world, concentrating even more of the world’s savings—and its financial risks—in a single currency managed by a single central bank.

THE LEAST BAD OPTION

In theory, the best, most stable international monetary system would be truly multipolar, with no single currency in a position of dominance but with several major currencies—each backed by deep financial markets, sound economic policies, and trustworthy institutions—anchoring international trade and finance. In the period before World War I, the British pound sterling, the French franc, and the German mark all denominated transactions and served as reserve currencies. When trouble struck, although sporadically, the countries’ central banks supported one another, helping to stave off broader financial panic. Renewed currency competition would force the competing governments, including the United States, to adopt responsible policies to avoid their currencies being shunned by investors. But given the economic and institutional malaise plaguing China, Japan, the United Kingdom, and the eurozone, such an outcome seems unly.

If the dollar loses its position of privilege and no single currency is able to replace it, the global currency system will become even more fragmented than it is now. Such a scenario could unfold if U.S. debt grew so large that investors began doubting its value and dumped it, if additional sanctions and tariffs drove countries to shun the dollar despite the costs, or if the Fed’s independence were seriously compromised, leading to a surge in inflation and a plunge in the dollar’s value. As things stand, if the dollar lost its position of privilege, it would be replaced not by a handful of strong currencies but by a number of weak ones, none backed by sufficiently robust financial markets or a central bank able and willing to serve as the world’s lender of last resort during a crisis.

The world needs a currency it can trust.

If the global economic system has no currency to anchor global investors’ trust, stress in financial markets could spiral into unstoppable turmoil. During the global financial crisis of 2008–9, for example, the Fed pumped a huge number of dollars into U.S. and international financial markets to prop up banks and corporations around the world that desperately needed dollars to meet their debt obligations and reinforce their balance sheets. Even though the United States had been the epicenter of the crisis, trust in the Fed helped prevent a terrible situation from becoming even worse. Investors who were anxious about the safety of their assets piled into Treasuries, an investment they trusted would be returned.

Greater dollar dominance, then, is the most ly scenario for the future. The danger of this outcome is that the United States will have even less incentive than before to be more fiscally responsible. If foreign investors remain eager to invest in U.S. financial markets, Washington will have little reason to reduce its budget and trade deficits. Fed policies, including interest rate changes, could cause whiplash effects for other countries. In 2013, for example, the mere prospect of the Fed reducing measures to keep U.S. interest rates low sent currencies in Brazil, India, Indonesia, and Turkey tumbling because investors around the world began anticipating higher returns on U.S. assets and pulled their money out of those countries’ stocks and bonds. As capital flows in and out of markets in response to the Fed’s actions rather than in response to their own monetary policy, other countries could be left bereft of policy tools to stabilize their economies and financial markets in such a scenario. Emerging-market and developing economies, which have shallow financial markets and rely heavily on foreign borrowing, often in dollars, are especially vulnerable to volatile capital flows and exchange rates. In a world of greater dollar dominance, those countries could face more frequent currency crises, capital flight, and debt distress.

As disconcerting as the dollar’s continued preeminence might seem, however, the world needs a currency it can trust. As threats to international financial stability accelerate, financial markets can ill afford to be left adrift. One way or another, the world will have to learn to live with currency disorder, and the dollar, at least for now, is the least bad option.

Loading…
Please enable JavaScript for this site to function properly.

You are reading a free article

Subscribe to Foreign Affairs to get unlimited access.

• Paywall-free reading of new articles and over a century of archives
• Six issues a year in print and online, plus audio articles
• Unlock access to the Foreign Affairs app for reading on the go

Subscribe

Already a subscriber? Sign In