When a country’s currency becomes the world

There is a paradox at the heart of the global economy. Having a global means of communication is not a bad thing. It reduces friction. Less currencies mean fewer price lists, fewer arbitrage opportunities (profit from price differences between markets) and less demand for multinational companies to hedge foreign exchange risk (FX) risks, that is, potential losses in the value of currency changes when conducting business across borders. A dominant medium of exchange smooths the business gear.

But the problem is not that the dollar plays this role. The problem is that it is both a global reserve currency, the most widely used currency in global trade, held by foreign central banks – and The national currency of the United States. This has had a dangerous impact on the accumulation of US dollars in the United States and foreign countries.

Dollar Trap

U.S. President Donald Trump and his followers say that the United States is paying nothing wrong with issuing global reserve currencies. To get the dollar required for international trade to get the dollar to repay debts denominated in dollars, they must run a current account surplus (exports exceed imports). This requires the United States to run a permanent current account defect (import exceeds its export).

Of course, as an issuer of the world’s reserve currency, at least in the short term, the United States can import whatever it needs and simply pay (USD) with financial claims (USD) without worrying about the USD.

This benefits consumers who like cheaper imported goods. But it is the cost for exporting countries, where workers produce real goods in exchange for financial claims that may never be redeemed for American goods. The result is a global transfer of wealth from foreign workers to American consumers. Meanwhile, foreign countries accumulated US dollars and acquired U.S. assets, including bonds, stocks, companies and land.

The key measure of this trend is Net International Investment (NIIP), which tracks the difference between a country’s external financial assets (things that Americans own abroad) and its external financial liabilities (things that foreigners own in the United States). The U.S. NIIP has deteriorated significantly from $1.7 trillion in 2008 to more than $24 trillion by the end of March 2025. In the fourth quarter of 2024, NIIP fell by $2 trillion, partly due to the strong dollar value increasing the value of U.S. assets held by foreigners. Annualized, the number will equal more than a quarter of GDP, which is amazing.

As foreign holdings in U.S. debt grow, interest and dividend payments also flow out of the U.S. economy, which is a steady income for overseas investors.

The economics sector’s view

One way to understand global economics is through a sectoral balanced view, a way to understand financial flows using an accounting identity. It divides the world into three sectors: private (home and business), government (tax and public expenditure), and foreign (trade balance with foreign countries).

Every dollar spent or savings in a sector must match the opposite balance of other sectors: (private sector balance) + (government sector balance) + (foreign sector balance) = 0

For example, when Americans import cars, the dollar leaves the country and emerges with a surplus from the foreign sector, a private sector deficit. When someone pays taxes, their savings decrease and government revenues increase.

In recent years, the U.S. government deficit (shown in purple in this chart) reflects the private sector surplus (orange). Meanwhile, the surplus (green) of foreign sectors comes at the expense of American households and companies. Even if the company’s profits are at record levels (about 12% of GDP), many households are struggling to save. Publicly traded companies pay shareholders about $2 trillion in dividends each year, but the money is concentrated among the wealthiest Americans and a growing number of foreign investors.

Our short history of external balance

During the early 1980s, during the administration of Ronald Reagan, the United States began to continue its current account deficit. In the late 1990s and early 2000s, the deficit expanded significantly, reaching more than 5% of GDP in the mid-2000s. Although the 2008 financial crisis temporarily reduced the deficit, it did not disappear.

As of 2024, the deficit remains large due to long-term imbalances in goods trade (major imports of consumer products and industrial inputs). The surplus in the service trade, Apple’s software, licensing of American film rights, and global use of U.S. financial services, is partly due to the gap.

These imbalances are not only economic accidents. They are structural features of a global financial system built around the US dollar.

Limitations of US dollar demand

Foreigners are accumulating American assets – not out of charity, but accumulation of necessity. They need US dollars to address international trade, US dollar-denominated debt and build FX reserves. But this accumulation is limited.

First, unless the U.S. trade surplus operates, foreigners are unable to exchange their claims for U.S. goods and services in total. Second, it means that non-U.S. Labor is producing real goods in exchange for paper claims that they may never redeem.

While the United States can print as much money as you want, that doesn’t mean the rest of the world will always want to hold them. You can only charge financial requirements from producers or real goods for so long. The dollar system trusts. At some point, this confidence may break down.

The US dollar’s status as the world’s reserve currency also depends on its stability. So far, no fired for holding too much dollars. However, no one wants to hold a wasted asset.

The hoarding of foreign central banks against the US dollar can prevent exchange rates from adjusting to prices where trade imbalances fall. As far as the dollar becomes a victim of its own success, it cannot be weak as a reserve asset. Its continued strength will hollow out the U.S. industrial base to export jobs and inflation to other countries until at least early 2025.

European value phantom

The Euro dollar market is an alternative access route to the dollar – which is incomplete. This is an offshore dollar financial system created by non-US banks. Despite its name, European values have nothing to do with the euro. They are dollar deposits held in foreign banks in London or the Caribbean.

You can think of European city markets as casinos. Players use chips as currency. They settled with chips represent and possible look Like the dollar, but not backed by the Federal Reserve Bank. The monetary system in the casino works well until someone with a big bonus wants to cash it out, or the player cannot repay the debt.

Offshore dollar markets operate until they don’t work. Without the corresponding credit limit of US institutions, European value will not be automatically converted to onshore dollars. When liquidity drys up, these credit lines will become difficult or unavailable. The Fed may step in – just like in 2008 and 2020 with swap lines, but no obligation to preserve the system. The swap line is a US dollar loan to foreign central banks, which in turn lend these dollars to borrowers in trouble (at your own risk).

The current government may point out that “unfriendly” countries are excluded from visiting these swap lines.

Ecuador gave up its currency and invested the US dollar in 2000, finding it difficult. The government defaulted twice (2008 and 2020) because it lacked the ability to issue its own currency during the crisis.

The situation of neutral reserve currency

The obvious solution is the above reserve assets. Ironically, this kind of thing has been around for decades: the Special Drawing Rights (SDR) created by the International Monetary Fund (IMF) in 1969. It is not the currency used by consumers, but the accounting unit used between governments. It exists only in digital form and is based on a basket of currencies (dominated by the US dollar and the euro).

Initially, SDR was associated with gold, as one unit represented slightly less than one gram (0.888671) of gold. Gold links were removed in 1973 after former U.S. President Richard Nixon “temporarily” suspended the 1971 dollar-to-dollar gold.

The SDR-based monetary system will still face challenges. In our fiat currency system (where trusts rather than commodities support currency), money can only be created by issuing an equal amount of debt. This will require a last lawsuit from global lenders to intervene in case the national central bank does not assume the debt capacity to create additional SDR liability. This would be a highly centralized system, with few unelected officials deciding to allocate credit.

The world will only know one interest rate. There is no national sovereignty over monetary policy.

Commodity currency? Be careful what you want

How to support the global reserve currency of commodities? Gold? Oil? Bitcoin?

The commodity-supported system brings discipline, but it also has rigidity. They restrict how much money the government can create because supply is related to commodity prices. When prices fall, the money supply decreases. The money supply becomes cyclical, leading to deflation and recession. It favors commodity-rich countries such as Russia and Saudi Arabia, while hurting import-dependent economies like Japan.

Bitcoin does not seem to be suitable as a medium of exchange, as its limited issuance can lead to hoarding. The expected price appreciation will mean that other commodities expressed in Bitcoin will reduce their value; they will deflate. Long-term periods of openness can damage the banking system, leading to depression and widespread unemployment.

The danger of fragility of small currencies

What if there is no new global reserve currency? What if the international monetary system is broken down into countries trying to use their domestic currencies to solve international trade? Imagine the friction of price adjustments almost every day in more than 20 different currencies and adjusting prices. The cost of hedging will explode and be inefficient.

In addition, currencies in smaller countries are usually the way speculators play. Their currencies are vulnerable to speculative attacks (when investors suddenly take out their money). Hot capital inflows – Short-term capital chasing high interest rates may disappear in the crisis. Exchange rate crashes. Import inflation rate. Living standards have declined.

Take Türkiye – Not exactly a slave to a country (16^Th the largest GDP). In 2016, the Turkish Lira was trading at 2.50 per USD. Today: More than 40. Nominal wages soared from 2,210 lira (about $1,000) in 2014 to 26,600 (~$665) in 2024. The average Turks are in dollars.

A collapsed currency can make energy imports unbearable. Cutting down forces can lead to social unrest.

Missed opportunities in the United States

The United States has never seriously pursued a transition to a neutral reserve system, which is a massive policy failure. It turns out that the ability to run a deficit without immediate punishment (i.e., currency depreciation) is too tempting.

The final game is right in front of you. Now, the United States is addicted to the deficit and no party can control its spending. The current government has not accelerated the cliff by alienating international creditors, rather than engineering landing. No one sank the leaked ship faster by grabbing the axe. But we are here.

((Kaitlyn Diana Edited this article)

The views expressed in this article are the author’s own and do not necessarily reflect the editorial policy of fair observers.