USD: The Inertia of Incumbency

Pretext

The United States is widely recognized as a superpower due to its abundant natural resources, formidable economic strength, unparalleled military capabilities, resilient political institutions, and cutting-edge technological innovation; all forged along a historical path that has established it as the preeminent global power since the mid-20th century. Without getting out of scope, I provided a summary table highlighting the factors that allow the US to establish its hegemonic status:

In USD we trusted

While all the above are certainly true, the primary reason allowing the United States to sustain its status for nearly a century depsite many challenges is, you guess it, USD.

The US dollar has maintained its position as the world's primary reserve currency for nearly eight decades, despite persistent cyclical challenges to its hegemony. As of 2024, approximately 58% of global foreign exchange reserves and 90% of energy transactions remain denominated in USD^op, even as geopolitical rivals like the BRICS bloc attempt to create alternative financial architectures^q. This resilience stems from historical path dependency established through the Bretton Woods system^r, strategic petrodollar agreements^s, and depth in liquidity and institutional trust^t. While the US debt crisis and geopolitical shifts have prompted debates about de-dollarization^u, the absence of viable alternatives with comparable market depth, relative political stability, and network effects continues to reinforce dollar dominance^vw.

In this article, we will briefly explore the origin of the USD-based monetary architecture, its structural advantages, its ongoing challenges by dissecting the intrinsic tie between USD and the US hegemonic status.

The Bretton Woods System: Post-War Monetary Architecture

The 1944 Bretton Woods Conference established the USD as the anchor of the international monetary system, pegging it to gold at $35/ounce while other currencies fixed their exchange rates to the dollar^xy. This institutional framework emerged from unique historical circumstances:

• The United States held two-thirds of global gold reserves after WWII^z
• European and Asian economies needed dollar liquidity for reconstruction^α
• The system created built-in demand for USD as central banks maintained dollar reserves to stabilize exchange rates^βγ

The International Monetary Fund (IMF) and World Bank – created at Bretton Woods – further entrenched dollar centrality by denominating loans and quotas in USD^δ. These institutions are instrumental in solidifying the modern global financial order with the USD at its center. During the world wars and the post-war era, historical literature and data depict a nuanced and gradual transition from sterling to the US dollar as the dominant reserve currency^εζ, marking the beginning of unipolar dollar-based era.

The Nixon Shock and Transition to Fiat Currency

Perhaps the most significant event in modern monetary history is President Nixon’s 1971 suspension of gold convertibility^ηθ, signifying a pivotal shift to fiat currency, with the dollar’s value now ultimately resting on three pillars:

1. The Federal Reserve’s monetary credibility
2. Strategic agreements with oil-producing nations
3. Continued use as the primary invoicing currency in global trade^ικ

This decision responded to the depletion of US gold reserves from 20,000 tons in 1950 to 8,333 tons by 1971, as foreign nations like France increasingly redeemed dollars for gold^λμ. The move severed the dollar’s formal link to gold but inadvertently strengthened its global role through subsequent petrodollar agreements^ν.

The Petrodollar System

The 1974 US-Saudi pact required oil sales in USD, creating self-reinforcing demand cycles^ξο:

• Oil importers needed dollars for energy purchases
• Exporters reinvested surplus dollars in US Treasuries
• This "recycling" mechanism deepened dollar liquidity pools

By 1980, 85% of global oil trades used USD, making it indispensable for energy markets^π. This system transformed the dollar into a quasi-commodity currency, with its value indirectly backed by the world’s most traded physical commodity. As fossil fuel is the foundation of modern society^ρ, the US Dollar continues to be the foundation of global financial system.

Structural Advantages Sustaining Dollar Primacy

Liquidity and Network Effects

The USD benefits from unmatched market depth:

• $7.5 trillion daily turnover in forex markets, with the USD involved in 88% of all trades (2022 data)^σ
• 60% of global debt securities denominated in dollars^τ
• 50-70% of international trade invoices use USD^υ

This liquidity creates powerful network effects – businesses and nations use dollars because others do, minimizing conversion costs, further reinforcing dollar dominance.

Institutional and Legal Frameworks

The US provides critical infrastructure for global finance:

• Rule of law for contract enforcement
• Deep capital markets with $53 trillion in financial assets^φ
• Central bank swap lines to ensure global dollar liquidity eg. During the 2020 COVID crisis, Federal Reserve swap lines provided $450 billion in liquidity to 14 central banks in effort to stabilize financial markets by providing foreign central banks with access to US dollars, demonstrating the dollar’s role as the global lender of last resort^χψ

Challenges to Dollar Dominance

The US Debt Crisis

As of 2024, the US federal debt stands at approximately 121% of GDP^ω, marking the highest level of public debt ever recorded in peacetime^a1, underscoring ongoing concerns about fiscal sustainability^b1. According to the 2024 Financial Report of the United States Government, under existing assumptions, the debt-to-GDP ratio is projected to exceed 200% by 2049 and reach over 500% by the end of the century, driven by persistent primary deficits and rising interest costs^c1. This trajectory implies that without policy changes, debt would grow faster than the economy indefinitely, imposing increasing burdens on future generations.

The ability to meet one's debt obligations is crucial not only for individuals but also for governments. Therefore, the U.S. debt crisis is closely linked to the status of the US dollar as the world's reserve currency. Historically, the dollar has been considered a "safe haven" asset, meaning global investors rely on U.S. Treasury bonds for stability. However, as US debt levels rise, concerns about fiscal sustainability are growing, leading to increased borrowing costs and potential economic instability. This could trigger a corrosion trust in the dollar-based financial system.

At what debt-to-GDP level does the first domino fall, potentially triggering a cascade that topples the unipolar, dollar-based global order? That question, debated by researchers worldwide, warrants a book-length exploration and is far beyond the scope of this article. However, in short, political and economic factors greatly complicate the path forward. While precise thresholds are elusive, the U.S. faces immediate fiscal challenges. In 2025, the US must navigate the debt limit, appropriations deadlines and expiring tax cuts, all within a context of substantial deficits and a narrowly divided Congress, making timely and sustainable fiscal adjustments extremely uncertain^d1. This political gridlock, coupled with rising debt, could create the conditions for a future fiscal crisis. As the Hoover Institution notes, America's debt is approaching levels that may trigger market panic, financial crises, and deep recession^e1. As Moody's downgrade of the US's credit rating signals, this is more than just a technical market event; it represents an emerging consensus that the United States' mounting debt burden has shifted from an abstract risk to a strategic constraint on U.S. power and leadership^f1.

Despite these high debt levels, several factors help mitigate risks to the dollar’s long-term stability:

• Approximately 65% of US dollars in circulation are held overseas, which externalizes inflation risks beyond the domestic economy^g1.
• The US Treasury market remains the global safe asset benchmark, supported by unmatched liquidity and depth^h1. As of May 2025, no other bond market approaches the $28.6 trillion size of the US Treasury market, reinforcing its central role in global financeⁱ¹.

Foreign confidence in the dollar remains relatively strong, as evidenced by foreign holdings of US Treasuries increasing to about $8.5 trillion in December 2024^j1, reflecting sustained demand for dollar-denominated assets despite debt concerns.

The Unintended “Sell America” Trade

President Donald Trump’s confrontational economic policies arguably undermined global trust in the US institutions; and by extension US assets including the dollar. His aggressive tariff impositions and political pressure on the Federal Reserve challenged the Fed’s independence, creating uncertainty and volatility across financial markets^k1. This turmoil led to a rare "sell America" trade, with simultaneous sell-offs in US stocks, bonds, and the dollar itself, which fell to a three-year low, reflecting a crisis of trust^l1m1.

The trade agenda of the Trump administration, for all intents and purposes, aims to address the dependency on critical imports as well as the national deficit and debt, the same fundamental issue that Ronald Reagan, the iconic Republican president, sought to tackle. This invites one of the most iconic comparisons in US presidential history, one that Trump himself often invokedⁿ¹.

In reality, the contrast between Reagan’s and Trump’s approaches is as day and night, when we examine their respective efforts to manage trade imbalances and currency valuation. The Plaza Accord of 1985, negotiated under Reagan’s administration, was a landmark multilateral agreement involving the US, Japan, West Germany, France, and the UK. It was designed to intervene cooperatively in currency markets to devalue the US dollar and address trade imbalances, particularly the US trade deficit. This accord was characterized by careful pre-negotiations, a clear framework for coordinated action, and mutual policy adjustments - such as Japan opening its markets and Germany implementing tax cuts. The Plaza Accord succeeded in depreciating the dollar by about 50% against key currencies over two years, temporarily easing trade tensions and preventing the escalation of protectionist trade barriers in the US^o1p1

In stark contrast, the "Mar-a-Lago Accord"^q1 a term coined during the Trump era, lacks the cooperative multilateral foundation and strategic framework that defined the Plaza Accord. Emerging amid rising tariffs and unilateral trade policies, it was declared abruptly without prior negotiations or an agreed framework among major economies. The internal contradictions within the Trump administration further complicated the dollar’s standing. Stephen Miran, chairman of the White House Council of Economic Advisers, characterized the dollar’s reserve currency status as a structural liability that forces persistent trade deficits and an overvalued dollar, proposing unconventional remedies including deliberate devaluation to foster a multipolar currency system^r1. Furthermore, Trump’s "America first" philosophy extended to his view of the dollar’s international role. He threatened harsh tariffs on countries attempting to reduce their reliance on the dollar, signaling a willingness to use the dollar’s dominance as a coercive tool in global trade. This approach disrupted the cycle whereby dollars flow abroad through trade deficits and return as foreign investment in US assets^s1.

This tectonic shift from Washington signalled a drastic change in how the Trump administration would manage the world order. The "reciprocal tariff" announced on the so-called "Liberation Day" risked destabilizing markets and eroding global confidence in US leadership, rather than fostering cooperation like other post-war administrations have.

Moreover, the tariff rate calculations underpinning this policy have been criticized for relying on an oversimplified formula - essentially equating the ratio of the trade deficit over imports and divide it by 2:

$$\text{"Reciprocal tariff"} = -\frac{1}{2} \times \frac{\text{Exports} - \text{Imports}}{\text{Imports}}$$

This method is detached from the complex realities of trade dynamics, capital flows, and currency valuation, rendering it an inaccurate and misleading tool for policy intervention^t1. The sweeping imposition of "reciprocal tariffs" triggered a sharp sell-off across US financial markets, forcing President Trump to swiftly backtracked and paused most of the tariffs within days^u1, restoring some magnitude of order in global financial markets, a development of which warrant a separate discussion.

In short, Trump’s trade policies, especially broad and frequently changing tariff implemetations, disrupted the well-established economic relationships and raised fears of recession, prompting investors to shed dollars rather than treat them as a safe haven asset. As Steve Kamin, a former Federal Reserve economist, noted, investors began viewing the dollar more as a risk asset than a flight-to-safety currency - a sentiment rarely seen throughout history. This shift marked one of the steepest declines in the dollar for a new presidency this century, with the US Dollar Index falling nearly 10% in Trump’s first 100 days of his second term^v1.

No Real Alternative Has Emerged

Despite growing skepticism about the US hegemonic status and efforts by emerging powers to challenge it, no viable alternative has yet materialized to rival the dollar’s global dominance, at least in the short term.

Limitations of BRICS De-Dollarization Attempts

The BRICS bloc - comprising Brazil, Russia, India, China, and South Africa - has made limited but strategic progress in challenging the dominance of the US dollar in global finance. Despite ambitious rhetoric, structural and political constraints have limited the effectiveness of these efforts.

While de-dollarization makes compelling headlines, JP Morgan suggests that transactional costs of transitioning to a multi-currency system (estimated at 1.5% of global GDP annually)^γ1 would ensure continued dollar primacy.

The Euro’s Limitations

The euro accounts for approximately 19.83% of allocated global foreign exchange reserves as of Q4 2024, making it the second-largest reserve currency after the US dollar^δ1. However, several structural challenges limit its potential to fully rival the dollar:

• Fragmented sovereign debt markets across the Euro Area create risks of financial instability and contagion^ε1.
• The absence of a unified fiscal authority hinders coordinated economic policy and the issuance of common Eurobonds^ζ1.
• The daily forex turnover for the euro is significantly lower than the US dollar, which impacts its liquidity and global usability^η1.

While the Euro Area's foreign exchange reserves totaled approximately $101.33 billion USD in April 2025^θ1, these structural factors continue to prevent the euro from functioning as a true alternative reserve currency.

The Yuan’s Structural Hurdles

Despite being the world's largest trading nation, China's yuan (renminbi) constitutes only 2.18% of allocated global foreign exchange reserves as of Q4 2024, according to the IMF’s Currency Composition of Official Foreign Exchange Reserves (COFER) data^ι1. Several factors constrain its internationalization:

• Capital account restrictions and limited currency convertibility constrain yuan internationalization^κ1.
• The People’s Bank of China lacks full independence, raising concerns about monetary policy credibility^λ1.
• Geopolitical distrust of the Chinese Communist Party’s governance and transparency further limit global acceptance^μ1ν1.
• Only about 3% of global trade invoices are denominated in yuan^ξ1.
• Offshore yuan bond issuances surged in 2024, reflecting progress but still limited global penetration^ο1.

Precious Metals and Digital Assets

Precious metals, particularly gold, with its role as a safe-haven asset and a hedge against currency devaluation, inflation, and geopolitical instability, remain a store of value but lack the liquidity and scalability to serve as a global reserve currency alternative. With that said, it is important to point out central banks worldwide have been significantly increasing their gold purchases in recent years, continuing this trend strongly into 2025. They have accumulated over 1,000 metric tons of gold annually for each of the past three years, more than doubling the average of 400–500 tons per year seen in the previous decade^π1ρ1. BRICS nations collectively hold significant gold reserves (about 5,700 tonnes), representing 16% of global gold reserves, but this has yet to translate into a coordinated gold-backed currency^σ1τ1υ1.

Cryptocurrencies such as Bitcoin reached a market capitalization of approximately $1.2 trillion in 2024 and have been gaining momentum on institutional adoption ^φ1. Though that is quite an impressive milestone, the relatively small scope recognition of institutional backing and regulatory uncertainties limit their utility as reserve assets. Bitcoin’s volatility remains extremely elevated in comparison to the US dollar.

Central Bank Digital Currencies (CBDCs) show promise for enhancing payment efficiency and financial inclusion, but none have yet achieved the scale or trust necessary to challenge the dollar’s dominance^χ1ψ1.

Final Words

As in 1944 and 1971, the world economy still needs a coordination mechanism – and no successor has managed to replicate the network effects, utimately making the USD the least bad option for the foreseeable future. The BRICS' fragmented efforts and the euro's and yuan's structural flaws confirm that dollar dominance still remains the path of least resistance in global finance.

Ultimately, it has been emphasized that the greatest threat to the dollar is not external competition but the erosion of trust in US political and legal institutions. The dollar’s strength relies on faith in the rule of law, contract sanctity, central bank independence, and democratic stability. Trump’s policies and rhetoric strained these foundations, raising concerns about the dollar’s long-term dominance despite the absence of viable alternatives^ω1a2.

Footnotes