In 1971, US President Richard Nixon shocked the global financial system by ending the dollar’s convertibility into gold, dissolving the Bretton Woods order and introducing a new era of floating exchange rates. Treasury Secretary John Connally, with striking candor, declared: “The dollar is our currency, but it’s your problem.” This phrase has echoed through decades of international financial policy, and is now revived as the title of Harvard University Professor Kenneth Rogoff’s latest book, Our Dollar, Your Problem: An Insider’s View of Seven Turbulent Decades of Global Finance, and the Road Ahead.

The phrase, once symbolic of American dominance, is now increasingly ironic. Connally’s bravado once marked the United States as the anchor of global finance, but by mid-2025, that anchor is dragging. The dollar is still dominant, but it is slipping in ways both cyclical and structural. This is not a collapse, but a re-evaluation.

The core issue is internal: fiscal indiscipline, governance erosion and waning market confidence. The dollar is beginning to behave differently in markets. Over the first six months of 2025, it has depreciated almost 11% on the US Dollar Index, even as US interest rates rise.

The inversion between yield and currency reflects a deeper shift. Market actors are building in a risk premium for US fiscal policy, reassessing American creditworthiness and coherence. This piece explores how we reached this point and what might lie ahead.

Interest rates rise, the dollar falls

Historically, when US interest rates increased, the dollar strengthened. Rising yields drew capital, creating upward pressure on the currency. But in 2025, the opposite has occurred. As two-year forward interest rates climbed in response to the Federal Reserve’s (or Fed’s) tightening path, the dollar weakened. This isn’t just a case of a strong euro (EUR) or yen; it’s a broad-based decline in dollar strength, signaling investor unease.

The catalyst appears to be a growing fiscal discount. Investors are no longer merely assessing yield differentials — they are evaluating sovereign credibility. US public debt stands at 119% of GDP, with annual deficits above 6% of GDP. Markets are demanding higher compensation for perceived fiscal risk, not for inflation protection, but for governance uncertainty.

When tariffs were reintroduced in April 2025 under the banner of industrial policy, the result was a triple dislocation: Equity markets dipped, bond yields jumped and the dollar fell. The episode mirrored the UK gilt crisis of 2022, where policy incoherence led to rising rates and a crashing currency. It was not a judgment on productivity or inflation — it was about trust.

The US Treasury market, once seen as the world’s safest asset, now embeds a premium that reflects policy risk. This is an early warning of a potential credibility crisis. The dollar’s decline amid rising rates inverts the logic of carry trades and undermines conventional asset allocation models. More alarmingly, it disrupts the network effects that sustain dollar dominance.

Currency hedging and the derivative feedback loop

As the dollar began to decline early this year, institutional investors responded with large-scale hedging activity. Asian insurers and pension funds, especially in Japan and Taiwan, had previously reduced hedge ratios to benefit from the strong dollar and lower hedging costs. But as sentiment reversed, many scrambled to restore protection.

This wave of repositioning triggered massive flows in the foreign exchange (or FX) derivatives market. According to Bank for International Settlements data, outstanding FX swaps and forwards involving the dollar rose to $130 trillion in notional value by the second quarter of 2025. Approximately 88% of these contracts had the dollar on one side. Trading volumes surged during Asian hours, indicating the geographic source of hedging demand. Investors didn’t dump dollar assets; they layered on protection against further currency depreciation.

This activity has created a reflexive loop. Hedging increases dollar selling pressure in the spot market, which in turn worsens performance, prompting more hedging. The feedback amplifies weakness. Moreover, rising US short-term interest rates raise hedging costs due to Fed tightening — increasing interest rates and reducing its balance sheet to curb inflation and slow down economic growth. This makes it even less attractive for foreign investors to hold unhedged dollar assets. Thus, we observe a paradox: Tighter monetary policy, which should support the currency, is contributing to its weakness through derivative market dynamics.

This shift challenges long-standing assumptions. Traditionally, the dollar has served as a safe haven. But this April and May, during episodes of global risk aversion — the tendency to prefer a certain, but potentially lower, outcome over a risky but potentially higher outcome — the dollar weakened alongside US equities and bonds. The dollar’s new behavior suggests that, to global capital, it no longer represents stability unconditionally.

The dollar’s political economy

What distinguishes the current environment is the erosion of political credibility. Markets are responding less to macro fundamentals than to institutional uncertainty. Budget dysfunction, tariff unpredictability and judicial–political standoffs have undermined the sense of coordinated policy.

This shift from economic to political risk has profound implications for the dollar’s valuation. Investors are increasingly focused on the lack of medium-term fiscal planning. Rising interest payments, especially those from 2023 that absorbed 17.98% of federal revenue, make the fiscal trajectory harder to stabilize.

Compounding the challenge is the absence of a political path to meaningful budget reform. One can recall the controversial 2010 Reinhart–Rogoff paper, “Growth in a Time of Debt,” which argued that debt above 90% of GDP is correlated with slower growth. Despite methodological criticisms, the underlying message — that high debt can constrain future policy options — is being vindicated. The key concern is that markets subtly reprice US markets by demanding more yield, reducing unhedged exposure or allocating elsewhere.

Thus, the dollar’s recent decline is about governance. The core of dollar strength — the perception that America can deliver policy coherence under pressure — is weakening. A currency’s value is much more than trade balances or interest rates; it’s a referendum on state capacity.

De-dollarization

The concept of de-dollarization is often exaggerated. Yet recent developments give the idea renewed relevance. Sanctions, reserve seizures — when a country’s foreign exchange reserves are frozen or confiscated by other governments — and geopolitical fragmentation have encouraged some central banks to diversify. The share of dollar-denominated reserves remains high — 58% as of July 2025 — but gold purchases, renminbi settlements and swap lines are expanding.

This isn’t a wholesale replacement of the dollar, but a drift toward multi-currency reserves. Emerging market central banks are increasing local currency trade arrangements and reducing their exposure to dollar volatility. The renminbi, also known as the Chinese yuan (RMB), has taken modest steps forward — not because it is more attractive, but because the dollar appears more vulnerable.

In this light, the global financial system is beginning to resemble the post-World War I period, where multiple powers replaced singular hegemony — one group’s dominance over others — with co-dominance. While the dollar remains central, it must now share space with the EUR, RMB and perhaps others. While cautious about predicting collapse, there are political risks accumulating. Rogoff notes that once trust erodes, rebuilding it requires major institutional restoration. The US may retain monetary tools, but credibility is a scarcer resource.

Market data reinforce this trend. Fewer central banks are intervening against the dollar, suggesting less reliance on it as a stabilizing anchor. Cross-border payment systems such as China’s Cross-Border Interbank Payment System are gaining ground. While these changes are incremental, they reflect the structural recalibration of the dollar’s role.

Implications for investors and policymakers

The current moment offers important lessons for market participants and policymakers. The dollar’s unusual behavior this year — declining even as yields rise — signals that traditional relationships are being redefined by political economy considerations. The dislocation reflects a deeper reconsideration of the US as a global steward.

For global investors, the episode underscores the need to reevaluate FX exposure assumptions. Currency risk is no longer secondary to credit or rate considerations. The cost of hedging dollar exposure has risen sharply, especially for European and Asian institutions, making unhedged positions less tenable. Expect more FX overlays, dynamic hedging and selective exposure trimming.

For US policymakers, the implications are even more urgent. The dollar’s global role has always been underwritten by institutional strength. If fiscal and political instability continues, the premium once afforded to US assets will shrink. That shrinkage might come through portfolio rebalancing, reserve diversification and pricing shifts. As we saw in April, all three can happen together.

This is not the end of dollar hegemony. However, it is the clearest signal in years that its foundation — trust in US stewardship — is eroding. Reserve currency status is a privilege earned through credibility and stability, not a guaranteed right. And in a world where capital flows are fast, transparent and reflexive, the cost of that privilege can rise quickly.

Redefining financial anchors in a fractured world

The dollar’s trajectory in 2025 reflects far more than temporary economic dislocation; it marks an inflection point in the architecture of global finance. For over seven decades, the dollar has operated not just as a medium of exchange or a reserve asset, but as the institutional anchor around which global financial stability, monetary policy coordination and cross-border capital flows were organized. This role was earned through a combination of macroeconomic dominance, institutional credibility, legal enforcement capacity and deep, liquid capital markets. Yet in the current geopolitical and macro-financial climate, global markets are reexamining those foundational attributes under mounting strain.

The erosion of fiscal discipline, recurrent brinkmanship over debt ceilings and weaponization of the financial system have sown global doubt about the long-term reliability of US economic stewardship. Concurrently, governance fatigue — visible in domestic polarization, policy unpredictability and regulatory fragmentation — has weakened the dollar’s reputational premium. On the international stage, geopolitical fragmentation and the rise of alternative financial channels like China’s digital yuan have introduced credible challenges to the dollar’s monopolistic status in the global monetary order.

Rogoff emphasizes that monetary sovereignty is not a license for fiscal indiscipline. In fact, the recent paradox of the dollar softening amid rising interest rates suggests a structural decoupling of market confidence from orthodox monetary signals. Traditionally, tighter monetary policy would boost the currency via interest rate differentials. But in a world where fiscal overhang, political dysfunction and external skepticism dominate, investors increasingly interpret rising rates less as a signal of macroprudence and more as a reflection of systemic vulnerability.

This is not merely a cyclical correction — it is a shift in the gravitational field of global finance. The reflexivity between policy choices and market perception is tightening. Investors, especially those holding dollar-denominated assets, must now factor in a risk premium not just for inflation or growth, but for governance credibility. Central banks, particularly in emerging markets, are quietly recalibrating their reserve strategies, diversifying into gold, special drawing rights (SDRs) — international reserve assets — and non-dollar assets.

Simultaneously, the US Federal Reserve and Treasury face a narrowing margin for error. The challenge is to stabilize the markets and, more significantly, restore narrative coherence around the dollar’s role in a multipolar world.

Ultimately, what defines a currency’s power is not its convertibility into gold, nor its dominance in current account flows. It is the credibility of the issuing state: the integrity of its institutions, the reliability of its policies and the consistency of its global commitments. In this regard, the US dollar remains dominant but no longer invulnerable. The foundational trust that underpinned the post-Bretton Woods dollar order shows signs of erosion. Whether this leads to a gradual transition, a sudden rupture or a resilient reassertion depends on both economic fundamentals and the ability of US leadership — monetary, fiscal and political — to adapt to a world no longer willing to accept unipolar financial governance without question.

The dollar will continue to hold a strong position in the future, but the tides are shifting. In the years ahead, its anchor position will be defined less by habit and more by how well it adjusts to the cross-currents of a multipolar, mistrustful world.

[Lee Thompson-Kolar edited this piece.]

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