Attempts to explain the dollar’s declining value in recent weeks will naturally focus on the growing likelihood of a US recession: the prospect of a sharp fall in growth tends to repel rather than attract capital inflows, and currency depreciation is the result.
Yet there may be a deeper cause of the dollar’s decline, rooted in the view of some within the Trump administration that the reserve currency status of the dollar is more of a burden to the US economy than a blessing.
Their remedy is to erode the dollar’s status in the international monetary system as part of an effort to weaken it permanently against other currencies, hoping that a more depreciated dollar might reduce the trade deficit and attract manufacturers to the US.
That view is very hard to defend. But if the administration really does aim to erode the dollar’s status, the international monetary system could enter a form of anarchy it hasn’t experienced since President Richard Nixon disconnected the value of the dollar from gold more than 50 years ago.
An abrupt deterioration of the dollar’s international status would sharply raise US borrowing costs, while offering China a much easier path to internationalising its own currency.
‘Dutch Disease’?
The view that the dollar’s reserve-currency status is a problem springs from the idea that its central role in the international monetary system is a form of ‘Dutch Disease.’ This is the phenomenon in which a country’s one big commodity export – natural gas, in the case of the Netherlands during the 1960s – leads to an appreciation of the currency that renders the rest of the economy, and especially its manufacturing sector, uncompetitive.
By analogy, some in the Trump administration argue that the dollar’s attractions as an international monetary haven have created so much demand for it that the exchange rate has become structurally overvalued and subsequently caused a loss of competitiveness. For them, this is a key factor in explaining why the share of workers involved in US manufacturing has fallen from 24 percent in 1974 to just 8 percent in 2024.
Vice President JD Vance set out a version of this argument when, as a Senator in 2023, he questioned the value of the dollar’s reserve currency status by drawing a parallel with Appalachia’s ‘resource curse.’ He argued that the importance of coal to the regional economy had led to a hollowing out of the region’s industry, leaving it less diversified and less dynamic than it might have been.
More recently Steve Miran, the chairman of President Trump’s Council of Economic Advisers, has argued that the reserve function of the dollar has caused ‘persistent currency distortions’ that have helped to saddle the US with unsustainable trade deficits, as foreign goods became cheaper relative to those produced domestically.
It is certainly true that the dollar is currently elevated and is close to being at its strongest level since 1985. But it is not at all clear that this has anything to do with its reserve currency status.
The past 50 years have seen the dollar go through huge swings, sometimes appreciating – as it has during the past decade – and sometimes depreciating, as it did for ten straight years from 2002 onwards.
Throughout these cycles, the level of the dollar has changed, without affecting its status to any considerable degree.
Indeed, it is particularly odd for members of the US administration to claim that the dollar’s current strength has anything to do with its reserve currency status, since the past decade has, if anything, seen that status diminish slightly, despite the dollar’s appreciation.
At the end of 2024, the dollar accounted for 58 percent of global foreign exchange reserves, while 10 years earlier that share was 65 percent.
Equally, the share of the US Treasury market owned by foreigners has also fallen sharply, from 50 percent in 2014 to around a third today.
It’s also worth noting that the UK’s trade deficit has steadily widened in lockstep with the US during the past few decades. You don’t need to have a reserve currency to see a steady, structural deterioration in your trade balance, since that’s only really determined by the gap between savings and investment.
A much more plausible way of explaining the rise of both the dollar and the US trade deficit during the past ten years is simply that the US economy has exhibited more vitality than many of its competitors. This was the decade of ‘US exceptionalism’, and it is naturally the case that the relative dynamism of the US economy attracted capital inflows into its equity and currency markets. The strong performance of the US economy, in other words, lies behind both the dollar’s strength as well as the rise in the trade deficit.
Gaining traction
For now, efforts to undermine the dollar’s international status might be hobbled by the fact that there are members of President Trump’s entourage – Treasury Secretary Scott Bessent for one – who seem to disagree with the views of Vance and Miran.
Yet it is too early to rule out the possibility, not least because the idea seems to be gaining broader traction. Taxes on foreign holdings of US securities, limits on foreign ownership, burdensome approval procedures or reporting requirements could all feature in potential future efforts by the US administration to undermine the dollar.
An additional tool might involve a unilateral US decision to suspend the open-ended currency swap lines the Fed has in place with the central banks of Canada, the Eurozone, Japan, Switzerland and the UK.
Until President Trump took office in January 2025, dollar dominance seemed resilient. The fact that virtually every country with a reserve currency participated in the sanctioning of the Russian central bank in 2022 meant that there was little incentive for hostile countries to abandon the dollar for other convertible currencies, as exposure to the others would add no geopolitical protection.
Moreover, the sharp distinction between the fully convertible dollar and the heavily controlled renminbi gave the dollar a notable advantage: holding a lot of renminbi is costly because its lack of convertibility means its international usefulness is limited.
But if the international monetary system cannot rely on the dollar’s full convertibility, or its availability in a crisis, it is entering unknown territory. Undermining the dollar’s global status would not only transmit huge amounts of additional uncertainty to the global economy, but would be a needless act of self-harm for the US.
David Lubin, Michael Klein Senior Research Fellow, Global Economy and Finance Programme.