For nearly eight decades, the US dollar has served as the backbone of the international economic system. It is the dominant currency for trade invoicing, the principal reserve asset for central banks and the anchor for many economies’ exchange-rate regimes. Its unique “safe-haven” status — its tendency to appreciate when the world is under stress — has allowed the United States to borrow inexpensively, sustain persistent external deficits and exercise disproportionate influence over global finance. For years, the world has treated this dominance as structural, almost natural, as if dollar primacy were a permanent feature of the global landscape rather than the outcome of deliberate policy choices and institutional credibility.

A new body of research, together with the policy turn toward tariffs, supply-chain reshoring and political pressure on US institutions, challenges that assumption. A recent paper by economists and professors Tarek Hassan, Thomas Mertens, Jingye Wang and Tony Zhang, presented at Brookings Papers,demonstrates that the dollar’s safe-haven premium is not only a product of financial depth and institutional strength but also fundamentally linked to US trade openness. When the US raises trade barriers or injects uncertainty into its economic governance, it quietly weakens the foundations that support the dollar’s global role. The emerging picture is one of slow-motion stress — a gradual erosion of the trade and institutional underpinnings that have long sustained America’s monetary privilege.

Rethinking why the dollar is dominant

Traditional explanations of dollar dominance, from American economist Barry Eichengreen’s work on reserve currencies to Indian-American economist Gita Gopinath’s research on dominant-currency pricing, emphasize three pillars: the size of the US economy, institutional credibility (rule of law, contract enforcement, central-bank independence) and the depth and liquidity of US financial markets. These factors make dollar assets convenient, safe and easy to trade.

Recent research does not dispute these explanations but highlights an additional and often overlooked mechanism: the structure of global trade itself. When a large share of international transactions is invoiced, financed and settled in dollars, the currency becomes deeply embedded in the operational infrastructure of world commerce. Empirical work by the American Economic Association and the National Bureau of Economic Research (NBER) shows that most world trade is priced in a few dominant currencies — above all the US dollar — which gives dollar movements outsized effects on global trade prices and quantities.

Firms borrow in dollars to hedge dollar-denominated revenues, banks manage dollar liquidity to support their trade clients and central banks hold dollar reserves to buffer their economies against trade-related shocks. This network of real-economy linkages helps explain why, during periods of global financial stress, investors take refuge in dollar assets rather than fleeing from them.

In this framework, the dollar’s safe-haven premium — the extra value, reflected in investors’ willingness to accept lower yields on US Treasuries and other dollar assets, that the dollar enjoys because of its safe-haven status — arises endogenously from the global trade and financial linkages that anchor demand for dollar liquidity. The more the world trades with and through the US, and the more balance sheets are structured in dollars, the more valuable dollar “insurance” becomes. The National Bureau of Economic Research shows that the convenience yield on US Treasuries — the willingness of global investors to accept low interest rates in exchange for safety and liquidity — is tightly linked to the valuation of the dollar in foreign exchange markets. This yield reflects global demand for dollar safety.

A related model of the collateral advantage of US government debt — the premium investors will pay for US government debt because Treasuries serve as superior collateral in global financial markets — explains why, in global downturns, dollar assets become especially attractive. Conversely, as global trade and supply chains diversify away from the US, and as alternative safe assets or invoicing currencies expand, the demand for dollar insurance — and thus the dollar’s safe-haven premium — is likely to erode over time.

What is “safe-haven stress?”

Safe-haven stress refers to periods when global investors urgently seek security during a crisis, but the usual safe-haven assets, especially the US dollar, come under unusual pressure. In most episodes of turmoil, the dollar strengthens because investors rush into dollar-denominated assets such as US Treasury bonds, which are considered exceptionally liquid and reliable. Safe-haven stress arises when this mechanism is strained: Demand for safety rises sharply, but the asset’s ability to absorb that demand or function as a dependable refuge is compromised.

One way safe-haven stress manifests is through disruptions in dollar-funding markets. During major geopolitical or financial shocks, global institutions scramble to secure dollar liquidity, causing spikes in the cost of borrowing dollars offshore and widening deviations from covered interest parity. The Federal Reserve Bank of Dallas shows that these distortions highlight an environment where the dollar is simultaneously in high demand yet increasingly difficult to obtain. This classic form of stress exposes deeper fragilities in the global financial system.

Safe-haven stress can also appear when the dollar’s traditional behavior weakens. If the global economy suffers a shock and the dollar does not appreciate, or even depreciates, it signals reduced confidence in its role as a universal refuge. Foreign Affairs argues that rising trade fragmentation and protectionism may erode the structural foundations of dollar dominance, reducing the automatic “flight to the dollar” during crises.

As more countries expand trade in alternative currencies or build regional financial systems, the dollar may command less automatic trust during global stress events. Research from the Brookings Institution suggests that prolonged trade conflicts and protectionist policies can weaken the global anchoring role of the dollar, further amplifying safe-haven stress.

The broader concern is that if the US dollar experiences sustained stress, the global financial system becomes more volatile. Investors lose a reliable anchor, crisis hedging becomes more difficult and US borrowing costs may rise as the safe-asset premium on Treasuries diminishes. The dollar remains the world’s primary safe haven, but safe-haven stress underscores a growing vulnerability: Its dominance now depends more on economic and geopolitical conditions that are shifting in ways unfavorable to the US.

Tariffs, tipping points and a multipolar future

To quantify these effects, Hassan and the other researchers built a calibrated general-equilibrium model connecting three elements: trade costs (tariffs), portfolio choices and the choice of anchor currency for smaller economies. Their key findings are sobering:

1. Higher tariffs erode the safe-haven premium.
   As trade with the US becomes costlier, global investors demand higher yields on US assets to compensate, raising interest rates and weakening the dollar’s crisis appeal.
   
2. Capital outflows and lower real wages follow.
   With higher funding costs, US firms invest less. Over time, this translates into lower productivity and real wages — an ironic outcome for a policy supposedly designed to protect workers.
   
3. Beyond a tariff threshold (around 26%), the global anchor can flip.
   In their simulations, once average effective tariffs reach about 26%, it becomes welfare-optimal for many smaller economies to stabilize their currencies against the euro rather than the dollar. The world shifts from a dollar-centric to a more multipolar monetary system.

This “26% threshold” is not a prophecy, but it is a powerful thought experiment. It tells policymakers that the dollar’s role as the global anchor is conditional. If the US government pursues protectionism for long enough, the rest of the world has both the motive and the means to adjust.

Markets are starting to notice

On April 2, 2025 — US President Donald Trump’s declared “Liberation Day” — the administration’s sweeping new tariffs provided a real-world demonstration of how trade policy shocks can move markets, echoing the dynamics documented in the Federal Reserve Bank of San Francisco (FRBSF)’s Economic Letter. Instead of behaving like a traditional safe-haven asset, the US dollar fell on the announcement, long-term Treasury yields rose and US equities underperformed their foreign counterparts after adjusting for the currency move.

According to the FRBSF analysis, markets interpreted the tariffs as raising economic risk and lowering future profit expectations: the S&P 500 dropped about 11% within days, dividend futures fell 6–8% over the next three years and the dollar depreciated notably against safe-haven currencies. Together, these reactions show that large, unexpected trade actions can tighten financial conditions and weaken risk sentiment rather than support the dollar or US assets.

Reuters, summarizing the Hassan research, put it bluntly: Higher tariffs at current levels “could weaken, but not yet reverse, the dollar’s reserve status.” The model’s tipping point sits at roughly 26%, which is above today’s effective rates, but not dramatically so. Safe-haven stress is already visible in price data, even if the system has not yet flipped.

Institutions still matter — but they are under pressure

Trade integration is only half the story. American economist Lael Brainard, in her review essay in Foreign Affairs, reminds us that the dollar’s dominance also rests on a dense web of institutions: an independent Federal Reserve (or Fed), credible statistical agencies, the rule of law and a track record of honoring international commitments.

Those institutions underpin the convenience yield on Treasuries. Brainard notes that this yield saves the US government on the order of hundreds of billions of dollars per year in interest costs, depending on how broadly it is measured. If investors begin to doubt the Fed’s independence, the integrity of US data or the reliability of US treaty commitments, that convenience yield shrinks.

Recent developments point in that direction. The administration has:

• Pushed tariffs to levels not seen in nearly a century.
  
• Signaled a willingness to disregard existing trade agreements.
  
• Publicly pressured the Federal Reserve to deliver lower interest rates and even attempted to remove Fed officials.

These actions have prompted warnings from other central bankers. The governor of the Bank of Canada, for example, has stated that political interference with the Fed is “raising questions” about the independence of US monetary policy and has “dented the safe-haven appeal of the US dollar.”

In combination with trade fragmentation, this institutional erosion amplifies safe-haven stress. Tariffs attack the trade channel, while political interference attacks the credibility channel.

Policy lessons: How not to squander exorbitant privilege

American economist Ben Bernanke argues that the international spillovers of US monetary policy reveal a larger truth: The dollar’s global role is neither immutable nor costless to maintain. The Fed draws disproportionate global scrutiny precisely because dollar funding markets remain deep, liquid and central to international finance, especially for emerging-market borrowers who rely heavily on dollar-denominated credit. Yet many of the traditional advantages associated with this dominance have weakened over time. Competition from other major currencies has intensified, the US share of global output has declined and the interest-rate advantage on US government debt has largely eroded.

At the same time, Bernanke highlights how safe-haven flows, a uniquely deep Treasury market and the global scale of dollarized credit also magnify risks when US policy becomes unpredictable. Sudden tightening cycles, sharp dollar appreciations or disruptive trade actions can raise the real burden of dollar-denominated debt abroad, strain emerging-market balance sheets and undermine confidence in the dollar’s stability. The lesson is straightforward: Preserving the benefits of the dollar’s central role requires disciplined monetary policy and consistent institutional reliability across the broader policy landscape.

1. Trade and finance cannot be separated.
   As French economists Pierre-Olivier Gourinchas and Hélène Rey have argued, the US enjoys its “exorbitant privilege” because it supplies the world with insurance in the form of safe assets. But that insurance value depends on credible, stable economic institutions. When trade policy becomes a source of uncertainty — as seen on Liberation Day, when sweeping tariffs triggered a fall in the dollar, a rise in long-term Treasury yields and underperformance of US equities — markets interpret the US as a source of risk. Trade shocks can therefore erode financial strength directly.
   
2. The dollar’s privilege is conditional, not guaranteed.
   The US earns cheap external financing only as long as global investors consider Treasuries the most reliable store of value. Policy choices that undermine institutional credibility — protectionist surges, fiscal brinksmanship or political interference with independent agencies — chip away at the safety premium embedded in US assets. Markets can reassess that premium quickly. Exorbitant privilege is not a birthright; it is an asset that must be actively maintained.
   
3. A more multipolar system is plausible.
   IP Morgan’s analysis indicates that the future is unlikely to be defined by sudden de-dollarization, but rather by a gradual drift toward a more multipolar monetary order. Should US policies weaken the appeal of the dollar, other anchors, including the euro and eventually a liberalized renminbi, could gain ground. For emerging markets, such a shift would bring both opportunities and risks: greater diversification of reserve and invoicing currencies, but also more complex exchange-rate management and capital-flow dynamics.

A slow-motion stress test

Hassan and his co-authors emphasize that the global system is not yet on the brink of rupture. Effective tariffs, though rising sharply, remain below the 26% threshold at which their model predicts a shift away from the dollar as the world’s anchor. Yet the direction of travel is unmistakable. Higher protectionism, open political pressure on the Federal Reserve and the increasingly aggressive use of sanctions are reshaping global perceptions of US reliability. None of these developments produces an immediate crisis, but together they erode the trust that underpins the dollar’s safe-haven premium.

This erosion is likely to proceed quietly and cumulatively. The early signals will not resemble dramatic headlines but subtle shifts in the architecture of global finance. They will be a slow rebalancing of central-bank reserves away from the dollar, thinner foreign participation in long-dated Treasury auctions and a growing inclination to use alternative safe assets such as the euro or Swiss franc during periods of turmoil. No single development constitutes a turning point. But taken collectively, they illustrate that dollar dominance is not a law of nature. It is a confidence-based equilibrium — and confidence can weaken.

For generations, the US enjoyed a reinforcing loop in which openness, institutional credibility and financial depth generated global demand for dollar assets, lowering US borrowing costs and cementing American leadership. Today, rising tariffs, institutional slippage and policy unpredictability threaten to unwind that virtuous cycle. The dollar remains the world’s leading currency, however.

What the Brookings analysis ultimately demonstrates is not that collapse is near, but that reserve-currency status carries obligations. If Washington allows short-term political imperatives to dictate trade policy, interfere with the Fed or undermine the stability of the broader policy framework, it will pay a price in the realm it can least afford to compromise: the credibility of the dollar itself.

In an increasingly fragmented global economy, the central question is no longer whether the dollar can remain dominant by default. Rather, is the US still prepared to maintain the economic openness, institutional integrity and policy predictability required to sustain the trust on which that dominance depends?

[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.