The biggest threat to dollar dominance is the US economy itself, top economists warn

• The biggest threat to dollar dominance is the US itself, two top economists said.
• That’s due to the risk of “severe deterioration” in the US’s financial situation.

Dollar dominance is here to stay – and the most dire threat to its status as the world’s top reserve currency is actually the US economy itself, according to two economists.

Steven Kamin, a former director of the Fed’s Division of International Finance, and Mark Sobel, a former Treasury Department economist, pointed to the dollar’s long-running incumbency as the world’s dominant currency in a new paper.

The dollar is the most widely used currency in the world in both trade and central bank reserves — and it will likely stay that way, Kamin and Sobel said, since the use of the greenback outpaces other currencies by such a wide margin.

The dollar accounted for one side of 88% of all daily global trade, according to the latest survey from the Bank of International Settlements. Meanwhile, it accounted for around 55% of all central bank reserves in the third quarter of 2023, far more than any other foreign currency, International Monetary Fund data shows.

Some commentators have warned a rival currency could soon displace the dollar. BRICS nations are already making efforts to phase the dollar out of trade, while countries like Russia and China have proposed creating a new currency to challenge the greenback.

But those threats are in fact pretty tame compared to the threat to the dollar stemming from the US itself, Kamin and Sobel warned, citing the risk of “severe deterioration” in the US’s financial and economic situation.

“Given the political polarization of the country, the dysfunction of the US Congress, and the disinterest of politicians of all stripes in curbing the widening US budget deficit, this is hardly unthinkable,” Kamin and Sobel said of the dollar’s potential dethroning.

“And should the result be a sustained rise in inflation, crowding out of private investment, heightened financial volatility, and reduction in the dynamism of the US economy, then the loss of dollar dominance would be the least of our worries. And those of the rest of the world,” the paper added.

Another risk stems from the fragmentation of global economies into separate blocs.

“In that case, global trade, productivity, and economic growth would likely be depressed, and implications for the international political and military stability would also be adverse.”

Other economists have warned the US’s precarious fiscal situation could risk the dollar’s top-dog status in global markets. The federal budget deficit is on track to notch $1.6 billion this year and $2.6 trillion ten years from now, according to a projection from the Congressional Budget Office.