Somewhere in the American Midwest, there is a typical gas station with a faded awning and a digital price board that has been reading higher than it used to. Because oil is priced and settled in US dollars, the price of a gallon of fuel is set in a chain of financial causation that most people filling up their tank have no reason to trace. The dollar’s position as the world’s reserve currency is so ingrained in everyday American economic life that it is almost imperceptible.
Even though you’re not aware of it, you sense it. Cheap mortgages, affordable imports, a government that can borrow at rates smaller countries would not be offered, a foreign policy arsenal that can isolate rivals with a banking transfer rather than a bomb. These don’t happen by accident. In 1965, French Finance Minister Valéry Giscard d’Estaing popularized the term “exorbitant privilege” to characterize what the dollar’s status cost everyone else and granted the United States for free. These are the compound benefits of this privilege.
The topic of what would happen if that status were to decline is not one that should only be considered in dire economic circumstances. For more than ten years, central banks all around the world have been gradually and covertly diversifying their reserve holdings away from dollar-denominated assets by adding gold, euros, and renminbi to portfolios that formerly contained mostly Treasuries.
Over the past 25 years, the dollar’s percentage of global foreign exchange reserves has decreased from about 70% to about 58%. It doesn’t feel like a catastrophe because the deterioration is slow enough. However, the same process that destroyed sterling’s reserve currency status between the first and second World Wars is described by slow erosion of that kind, compounded over time; this shift similarly appeared manageable until it wasn’t.
Borrowing prices would be the most obvious way for Americans to experience the loss. Due in part to the worldwide demand for Treasury bonds, which keeps yields lower than they otherwise would be, the U.S. government today has over $36 trillion in national debt, which is serviced at manageable interest rates. When that demand is eliminated, the government must provide greater yields to entice buyers because central banks are no longer required to keep dollars to support their own currencies.
Mortgage rates, auto loans, and the price of federal borrowing for everything from Medicare to defense are all impacted by this. When interest payments take up a greater portion of the federal budget, the social arithmetic completely shifts. Current programs would have to contend with the debt service burden in a different way than they do now.
For households, the effects of inflation are more immediate. The United States imports a significant amount of what Americans purchase, including consumer electronics, apparel, medicinal ingredients, automobiles, and the oil that drives nearly everything. A declining dollar increases the cost of imports. The Federal Reserve may respond by tightening monetary policy, but doing so in a setting where borrowing rates are already increasing due to structural factors puts the economy in a difficult-to-escape recession.
The economists who simulate these scenarios believe that the effects of growth and inflation would occur simultaneously rather than successively, which is the combination that causes the greatest amount of social and political strain. Although it may be the least obvious to the average American, the geopolitical aspect may have the most impact on the nation’s standing in the globe.
The capacity to impose sanctions on rivals, such as Iran, Russia, North Korea, and others who have been subjected to dollar system exclusion as a tool of foreign policy, is based almost completely on the idea that denying someone access to dollar-denominated trade is equivalent to denying them access to the majority of international trade. That lever diminishes or vanishes completely in a world where major economies engage in bilateral trade in euros, yuan, or an alternate settlement system created by the BRICS.
