In recent years, the US dollar’s position as the world’s primary reserve currency and the bedrock of international transactions is facing unprecedented scrutiny and challenges. The dollar, which historically tended to strengthen during periods of economic or geopolitical conflict, has recently exhibited unusual behavior, signaling that a subtle shift might be underway in the international monetary system.
One signal of this change comes from the actions of international rating agencies. Following Standard & Poor’s downgrade of the US sovereign credit rating from AAA in 2011, Moody’s recently lowered the US government’s credit rating from Aaa to Aa1. This means the United States has now lost its top credit rating from all three major international credit rating agencies (S&P, Moody’s, and Fitch). The downgrades reflect concerns about the US’s accumulating debt burden, fiscal uncertainty, and political polarization, factors that could weaken the US’s future fiscal strength and policy stability, thereby impacting investor confidence in US Treasury bonds.
Concurrently, central banks and sovereign wealth funds around the world are adjusting their foreign exchange reserve compositions. Some countries, including emerging economies like China, India, and Brazil, as well as some traditional allies, are reducing their holdings of US Treasury bonds to varying degrees, increasing gold reserves, or shifting investments towards other currencies and assets. While this diversification trend has not yet fundamentally shaken the dollar’s dominance, it reflects countries’ strategic considerations to reduce reliance on a single currency and mitigate risk.
History shows that major crises are often catalysts for international monetary system change. As Milton Friedman said, “Only a crisis – actual or perceived – produces real change.” The British pound showed signs of strain during the Franco-Prussian War and was gradually replaced by the dollar after World War I, a transition that reflected the waxing and waning of geopolitical and economic power. Today, new geopolitical risks, adjustments in global trade patterns, and uncertainty in the policy directions of major economies may also be catalyzing a shift in the international monetary system towards greater multipolarity.
The recent weakening of the dollar, particularly its decline during times when it would traditionally strengthen due to safe-haven demand, has attracted widespread attention. For example, in the initial months after Donald Trump’s return to the White House, as his administration announced, modified, and even suspended a series of unilateral tariff measures, the dollar did not surge as expected. Instead, it experienced a notable decline, cumulatively falling by about 6% against a basket of world currencies at one point. Behind this anomaly is a complex interplay of multiple factors.
One of the primary factors contributing to the dollar’s recent significant decline is the concern over the uncertainty of the Trump administration’s trade policies and their potential economic impact. Capricious import tariff plans and potential trade wars have heightened market fears of an economic slowdown or even recession in the United States. This uncertainty has sown doubts among investors about the dollar’s durability as a reliable safe-haven asset during turbulent times, prompting some capital outflows.
Furthermore, expectations regarding the future direction of the Federal Reserve’s monetary policy are also a key factor influencing the dollar. As concerns about a potential economic slowdown intensify, market expectations of the Fed potentially shifting towards interest rate cuts have risen. Lower interest rates typically lead to a weaker dollar because they make dollar-denominated assets relatively less attractive, leading investors to seek higher returns in other countries or regions.
However, analysts widely believe that beyond these cyclical or policy-related short-term factors, deeper concerns are undermining the dollar’s long-term appeal and foundation of trust. A dominant international currency’s status depends not only on the issuing country’s economic and financial strength but, more profoundly, on the soundness and stability of its institutions. This means requiring robust democratic institutions, the rule of law, an independent central bank, free and fair elections, and an independent press.
The evolution of the US domestic political environment, particularly the potential for policy unpredictability during a possible second Trump term, challenges to established institutional norms, and intensified political polarization, is causing the international community and investors to worry whether the stability of US institutions is being tested. This wavering confidence in the US political system and its institutions represents a more fundamental risk to the dollar. After all, the dollar’s “Exorbitant Privilege” as the global reserve currency – including the ability for the US government and corporations to borrow at lower costs and the unparalleled liquidity and depth of US financial markets – is largely built upon the international community’s high degree of trust in the US’s economic strength, policy stability, legal environment, and the openness of its financial markets. If this foundation of trust is eroded, the dollar’s privilege will also face challenges.
The US’s burgeoning public debt is another significant factor exacerbating market concerns. The current US federal government debt has reached its highest level since World War II and is projected to continue growing in the foreseeable future. While the market generally considers a US default unlikely, the continuously climbing debt level can raise concerns about future inflationary pressures, the government’s ability to service its debt, and fiscal sustainability. High debt levels may limit the US government’s fiscal space to respond to future economic shocks or crises and might also prompt investors to demand higher yields to hold US Treasury bonds, thereby increasing US borrowing costs, which contradicts the low-cost borrowing advantage a reserve currency should provide.
Despite these challenges, the dollar’s global dominance is deeply entrenched, and its weakening or replacement will not happen overnight. A complete shift of reserve assets from one currency to another would require monumental and fundamental transformations in the global financial system, economic growth models, and geopolitical landscape. Any such transition would be an exceedingly slow and complex process. Overseas investors hold trillions of dollars worth of US stocks, bonds, and other assets. Adjusting or “unwinding” these massive positions would necessitate gradual operations over a long period and cannot be accomplished overnight.
Therefore, a more realistic forecast is that the world is slowly entering a multipolar currency system. The dollar will still hold a dominant position within it, but its influence and share relative to other major currencies (such as the Euro, the Renminbi, and potentially future digital currencies or regional currency blocs) may gradually decline. Its dominance will likely no longer be as unchallenged as in the past.
Part of the reason the dollar holds its current position is its enormous economic scale – the US economy is still roughly equivalent in size to the combined economies of China (second-largest), Germany (third), and Japan (fourth). This vast economic scale provides the liquidity and depth required by the dollar. Furthermore, the historical lack of sufficiently strong and reliable competitors has also been a significant factor in maintaining the dollar’s status. In the 1990s, the Japanese Yen was considered a potential challenger during Japan’s economic zenith, but subsequent stagnation and financial system issues prevented it from realizing that potential. In the early 21st century, after the Eurozone was established, the Euro was once seen as a currency capable of rivaling the dollar; however, the subsequent credit and sovereign debt crises on the European continent exposed structural problems within the Eurozone and weakened the Euro’s standing. Major events within the US itself, including the unilateral exit from the Bretton Woods system and the gold standard in 1971, and the 2008 global financial crisis, also sparked doubts about the dollar’s dominance. Yet, the dollar ultimately held its ground, largely due to the resilience of the US economy, the depth of its financial markets, and the absence of strong alternatives at the time.
Facing the prospect of a potentially continued weakening dollar, economies worldwide are learning to adapt. This adaptive adjustment is evident on multiple levels, such as some central banks rebalancing their reserve allocations and the slow increase in the use of non-dollar currencies in international trade and investment settlement. In recent times, as some investors have sought to hedge against potential losses from dollar exchange rates or policy risks, European and Japanese currencies and government bond markets have seen significant capital inflows, confirming the trend of funds seeking relatively safe havens and stable returns globally. Some analysts even suggest that in anticipation of reduced US military support, EU countries have increased defense spending, which indirectly boosts economic activity and the bond market within Europe, as investors in this context favor safe and predictable investment opportunities.
Ultimately, the most crucial cornerstone supporting the dollar’s international status is trust – trust in the US economy, trust in the stability and predictability of US policy, trust in the openness of US financial markets, and trust in US institutions and the rule of law. Historically, the US, with its economic vitality, technological innovation capabilities, and relatively open and transparent system, acted like a beacon guiding the direction of the global economy and earned widespread trust. However, if the beacon’s light dims due to internal uncertainty and external challenges, if the signals from the US leave the world feeling confused or even facing “a state of chaos,” then international confidence in the dollar will inevitably erode, and doubts about the US’s future prospects will arise.
If “trust,” the foundation maintaining the global economic order, is eroding worldwide, or if the consensus among nations based on common rules and values is being tested, then the situation of the dollar being “solely dominant” will naturally face challenges and pressure to disperse. A long-term decline or a fall in its relative status will be an inevitable trend. And this process of “fragmentation” from dollar dominance towards a multipolar currency system is destined to be a difficult and lengthy evolution.