US policies risk dollar status, analysts warn

The United States is undermining global trust in the dollar and risking the currency's decades-long primacy, potentially causing a fragmentation of the international monetary system, experts said during a discussion at the Peterson Institute for International Economics in Washington.

At the event on April 24 titled "Does changing the trade regime change the dollar regime? To Mar-a-Lago and beyond", speakers said policies aimed at reinforcing US power could undermine its economic advantages, including the "exorbitant privilege" of the dollar, a term coined by Markus Brunnermeier, a nonresident senior fellow of the Peterson Institute and a Princeton University professor.

Maurice Obstfeld, also a senior fellow at the institute, said the current US approach replaces multilateral collaboration with "economic coercion", aiming to create a kind of "co-prosperity sphere" in which partners gain benefits by facilitating US objectives.

He listed potential tools, including setting exchange rates beneficial to the US, erecting barriers against China and Chinese products, and pressuring allies to finance US deficits by buying US Treasury securities.

That approach, Obstfeld said, is underpinned by flawed "narratives of victimization" and ignores the considerable benefits the US derived from the postwar multilateral system. More critically, it undermines the foundations of the dollar's global primacy, he said.

"If you look at the foundations of US currency primacy, all of them seem to be becoming weaker, if not disintegrating," he said, citing deteriorating fiscal probity, questions surrounding Federal Reserve independence, and declining trade openness.

Obstfeld dismissed the "myth" that the dollar's global role is the primary driver of US current account deficits, saying that global accumulation of dollar reserves has flattened relative to GDP. The damage to international trust could be severe and long-lasting, he said.

"The problem with trust is that you can destroy it quickly. You can't rebuild it very quickly, and the destruction in the last … 100 days has been epic."

'Exorbitant privileges'

Brunnermeier detailed the unique advantages the US stands to lose, framing them as three distinct "exorbitant privileges".

The first is commonly understood as "convenience yield", which means the lower interest rate that the US pays on its debt, he said.

The second is the ability to issue debt that functions as a global safe asset, which others are willing to hold and roll over indefinitely, effectively allowing the US to "run a current account deficit forever".

The third privilege is the dollar's safe haven status, a term that describes capital flowing into US Treasury securities during global crises, so the US can finance stimulus cheaply when others cannot.

"All of these three privileges are very valuable to have," Brunnermeier said, adding that the United States "worked very, very hard to build up this status".

However, he said, current policy attempts, described as potential "global financial repression" to keep US interest rates low while weakening the dollar via coercion, would risk undermining those advantages, "particularly the crucial tradability and perceived safety of US Treasurys".

The uncertainty generated by those policies acts "like a tax without any revenue", forcing the US government to pay a higher risk premium on its debt as the safe asset status becomes "shaky", he said.

That uncertainty could spur other regions to develop their own safe assets. Brunnermeier acknowledged the potential for a more multipolar world with regional zones centered on the dollar, renminbi, euro and yen.

Warwick McKibbin, a nonresident senior fellow at the Peterson Institute and a professor at the Australian National University in Canberra, discussed the tangible economic costs of US tariff policies and heightened uncertainty.

US tariffs alone would shrink the US economy by more than 1 percent by next year, McKibbin said. If trading partners retaliate, the damage deepens significantly, potentially reducing US GDP by more than 2.25 percent, he said.

Economic contraction

Adding a 100-basis-point risk premium shock to account for lost confidence could cause the dollar to depreciate sharply — potentially 15 percent combined with tariffs and retaliation — and trigger further economic contraction as capital flees and investment shrinks, he said.

"Higher risk, high volatility destroys economic activity, and that's the risk you take when you have uncertain economic policies."

McKibbin said he doubted the US administration's claims that tariff revenues could finance large fiscal plans, saying the mathematics is "extremely optimistic".

Adam Posen, president of the Peterson Institute, talked about the link between US foreign policy, security guarantees and the dollar's role. The dollar's dominance was never based solely on economics but also relied on the US security umbrella, a factor now being undermined, he said.

"In essence there were two open secrets that helped explain why the dollar was dominant," Posen said. "The first is ... the least ugly contest ...But the second was that the security regime, which was tied to the US, actually mattered."

He cited the franc of the African Financial Community's links to France and Germany's holding of dollars during the Cold War, suggesting that security ties heavily influenced currency choices.

"What's happening is the security, economic and financial guarantees all combined to make the insurance proposition offered by the US valuable," Posen said. "You're essentially now offering from the US a higher premium for lower insurance."

The shift could reverse capital flow dynamics, he said. Instead of fleeing to the dollar during turmoil, capital may flee if the US is perceived as the source of instability. That contributes to the "decentering" of the dollar, Posen said, a marked decline in the currency's centrality, but not its disappearance.

The consensus among the Peterson Institute panelists was that current US policies are placing the dollar's unique global position at risk.

The potential outcome, Obstfeld said, referring to Ernest Hemingway's description of bankruptcy, "gradually and then suddenly", leads to a more fragmented and potentially less stable global monetary system, with significant costs for both the US and the world.

yifanxu@chinadailyusa.com