There’s a paradox at the heart of the global economy. Having one global means of exchange isn’t a bad thing. It reduces friction. Fewer currencies mean fewer price lists, fewer arbitrage opportunities (profiting from price differences across markets) and less need for multinational corporations to hedge foreign exchange (FX) risk — that is, the potential losses from changes in currency values when doing business across borders. A single dominant medium of exchange smooths the gears of commerce.

But the problem isn’t that the US dollar plays this role. The problem is that it is both the global reserve currency — the currency most widely used in global trade and held by foreign central banks — and the national currency of the United States. That creates dangerous repercussions for both the US and foreign nations’ accumulation of US dollars.

The dollar trap

US President Donald Trump and his followers aren’t wrong in saying the US pays a price for issuing the global reserve currency. For foreign countries to obtain US dollars, which they need for international trade and to repay dollar-denominated debts, they must run current account surpluses (exporting more than they import). That requires the United States to run perpetual current account deficits (importing more than it exports).

Of course, being the issuers of the world’s reserve currency allows the US to import anything it desires and simply pay with financial claims (US dollars), without the fear of devaluing the dollar, at least in the short term.

This benefits US consumers, who enjoy cheaper imported goods. But it comes at a cost to exporting countries, where workers produce authentic goods in exchange for financial claims that may never be redeemed for US goods. The result is a global wealth transfer from foreign laborers to American consumers. Meanwhile, foreign countries accumulate dollars and acquire US assets — including bonds, stocks, companies and land. 

A key measure of this trend is the Net International Investment Position (NIIP), which tracks the difference between a country’s external financial assets (what Americans own abroad) and its external financial liabilities (what foreigners own in the US). The US’s NIIP has deteriorated significantly from less than negative $1.7 trillion in 2008 to more than negative $24 trillion at the end of March 2025. In the fourth quarter of 2024, NIIP declined by more than $2 trillion, partly due to the strong dollar that increased the value of US assets held by foreigners. Annualized, the figure would be equal to more than a quarter of GDP, a staggering amount.

As foreign holdings of US debt grow, so do interest and dividend payments flowing out of the US economy — a steady drain of income to overseas investors.

Sectoral view of economics

One way to understand global economics is through the sectoral balance view, a way of understanding financial flows using accounting identities. It breaks the world down into three sectors: private (households and businesses), government (taxation and public spending) and foreign (trade balance with foreign countries). 

Every dollar spent or saved by one sector must be matched by an opposite balance in one or both of the others: (Private Sector Balance) + (Government Sector Balance) + (Foreign Sector Balance) = 0

For example, when Americans import a car, dollars leave the country and show up as a surplus in the foreign sector and a deficit in the private sector. When someone pays taxes, their savings decrease, while the government’s revenues increase.

In recent years, the US government’s deficit (shown in purple in this chart) mirrors the private sector’s surplus (orange). Meanwhile, the foreign sector’s surplus (green) comes at the expense of US households and firms. Even though corporate profits are at record levels — around 12% of GDP — many households are struggling to save. Publicly traded corporations pay about $2 trillion annually in dividends to shareholders, but that money is concentrated among the wealthiest Americans — and increasingly, foreign investors.

A brief history of US external balances

The US began running persistent current account deficits in the early 1980s, during the administration of President Ronald Reagan. The deficits widened significantly in the late 1990s and early 2000s, reaching over 5% of GDP during the mid-2000s. Although the 2008 financial crisis temporarily reduced the deficit, it did not disappear. 

As of 2024, the deficit remains large, driven by a chronic imbalance in goods trade (heavy imports of consumer products and industrial inputs). The shortfall is partially offset by a surplus in services trade, exports like software from Apple, licensing of American movie rights and global usage of US-based financial services.

These imbalances are not merely economic accidents; they are structural features of a global financial system built around the dollar. 

The limits of dollar demand

Foreigners are accumulating US assets — not out of charity, but necessity. They need dollars to settle international trade, service dollar-denominated debts and build FX reserves. But this accumulation has limits.

First, foreigners cannot redeem their dollar claims for US goods and services, in total, unless the US runs a trade surplus, which it doesn’t. Second, it means non-US labor is producing real goods in exchange for paper claims that they may never redeem in kind.

While the US can theoretically print as many dollars as needed, this doesn’t mean the rest of the world will always want to hold them. You can force-feed financial claims to producers or authentic goods only for so long. The dollar system rests on confidence. At some point, this confidence could break. 

The dollar’s status as the world’s reserve currency also depends on its stability. So far, no central banker has been fired for holding too many dollars. However, nobody wants to hold a wasting asset. 

The hoarding of US dollars by foreign central banks prevents the exchange rate from adjusting to a price where trade imbalances would decline. Insofar as the dollar is a victim of its own success, to be a reserve asset, it cannot be weak. Its continued strength, at least until the beginning of 2025, hollowed out the US industrial base, exporting jobs and inflation to other nations.

The Eurodollar mirage

An alternative access route to US dollars — and it’s an imperfect one — is the Eurodollar Market. This is a global financial system of offshore US dollars created by non-US banks. Despite the name, Eurodollars are not related to the euro. They are dollar deposits held in foreign banks, often in London or the Caribbean.

You can think of the Eurodollar market as a casino. Players use chips as currency. They settle bets with chips that represent and may look like dollars, but aren’t backed by the Federal Reserve Bank. The monetary system within the casino works fine until either someone with large winnings wants to cash out or a player is unable to repay their debt.

Offshore dollar markets function until they don’t. Eurodollars are not automatically convertible into onshore dollars without a corresponding credit line from a US institution. When liquidity dries up, those credit lines become hard or impossible to obtain. The Federal Reserve may step in — as it did with swap lines in 2008 and 2020 — but it is under no obligation to save the system. Swap lines are dollar loans to foreign central banks, which, in turn, lend these dollars to borrowers in distress (at their own risk). 

The current administration will likely make a point of excluding “non-friendly” countries from access to those swap lines. 

Ecuador, which abandoned its own currency and dollarized in the year 2000, found out the hard way. The government defaulted on dollar-denominated debt twice (in 2008 and 2020) because it lacked the ability to issue its own currency during a crisis.

The case for a neutral reserve currency

The obvious solution is a supra-national reserve asset. Ironically, such a thing has already existed for decades: the Special Drawing Right (SDR), created by the International Monetary Fund (IMF) in 1969. It is not a currency used by consumers but rather an accounting unit used between governments. It only exists in digital form, based on a basket of currencies (dominated by the US dollar and the Euro). 

Initially, the SDR was linked to gold, as one unit was set to represent slightly less than one gram (0.888671) of gold. After Former US President Richard Nixon “temporarily” suspended the dollar’s convertibility into gold in 1971, the gold link was removed in 1973.

An SDR-based monetary system would still face challenges. In our fiat monetary system (where trust rather than commodities backs currency), money can only be created by issuing an equal amount of debt. This would require a global lender of last resort to intervene in case national central banks ran out of debt-bearing capacity to create additional SDR liabilities. It would be a highly centralized system with few potentially unelected officials deciding over the allocation of credit. 

The world would know only one interest rate. There would be no national sovereignty over monetary policy.

Commodity currencies? Be careful what you wish for

What about backing a global reserve currency with commodities? Gold? Oil? Bitcoin?

A commodity-backed system brings discipline — but also rigidity. They restrict how much money governments can create, since the supply is tied to commodity prices. When prices fall, the money supply shrinks. The money supply becomes pro-cyclical, causing deflation and recessions. And it favors commodity-rich nations like Russia and Saudi Arabia, while hurting import-dependent economies like Japan.

Bitcoin appears to be unsuitable as a medium of exchange, as its limited issuance may lead to hoarding. Expected price appreciation would mean that other goods expressed in Bitcoin would fall in value; they would deflate. Prolonged periods of deflation can harm the banking system, leading to depression and widespread unemployment.

The dangers of small currency fragility

What if there won’t be a new global reserve currency? What if the international monetary system disintegrates into countries trying to use their domestic currencies to settle international trade? Imagine the friction of having to price your product in 20+ different currencies and adjusting prices almost daily. Hedging costs would explode, and inefficiencies soar.

Furthermore, the currencies of smaller nations often serve as playthings for speculators. Their currencies are vulnerable to speculative attacks (when investors suddenly pull out money). Hot money inflows — short-term capital chasing high interest rates — can vanish in a crisis. Exchange rates collapse. Imported inflation spikes. Living standards fall. 

Take Turkey — not exactly a minion of a nation (16^th largest by GDP). In 2016, the Turkish lira traded at 2.5 per dollar. Today: over 40. Nominal wages soared from 2,210 lira (~$1,000) in 2014 to 26,600 (~$665) in 2024. The average Turk is poorer in US dollar terms. 

A collapsing currency can make energy imports unaffordable. Resulting power cuts may lead to social unrest.

America’s missed opportunity

The US never seriously pursued transitioning to a neutral reserve system, a massive policy failure. The ability to run deficits without immediate punishment (i.e., currency depreciation) proved too tempting.

The endgame is in sight. The US is now addicted to deficits, with neither party being able to rein in spending. Rather than engineering a soft landing, the current administration seems eager to speed toward the cliff by alienating international creditors. No one sinks a leaking ship faster by grabbing an axe. But here we are. 

[Kaitlyn Diana edited this piece]

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