Could the Dollar Be in Trouble – If So, What Then?

How Long Can This Continue?

This is the underlying question in several books and articles that have been published recently, most notably Kenneth Rogoff’s “Our Dollar, Your Problem,” and Barry Eichengreen’s “Money Beyond Borders: Global Currencies from Croesus to Crypto” — the latter of which is the subject of this review.

Eichengreen, a distinguished professor of economics and political science at the University of California, Berkeley, says that “The CBO’s [Congressional Budget Office’s] long-term budget outlook for 2025 shows debt in the hands of the public as leaping from 100 percent of GDP at the end of the year to 118 percent in 2035, 136 percent in 2045, and 156 percent in 2055…In thirty years, interest payments will absorb more than a quarter of federal revenues.”

Although there used to be, in years past, great concern about budget deficits and the increasing national debt, nobody seems to be terribly concerned about it anymore. Budget-busting measures like pandemic relief subsidies and the “Big, Beautiful Bill” get passed with barely a murmur about budget deficits.

But there is obviously an ultimate limit. If, per the CBO, interest payments do increase in 30 years to more than a quarter of federal revenues, in 40 or 50 years could they absorb 100 percent? This is impossible, because if that were to happen, there would be nothing left to spend on anything else. An extreme hypothesis perhaps, but it shows that there actually is a hard limit.

No Easy Solutions

The federal debt has increased at a rapid pace in the last 25 years, from 30 percent of GDP to 100 percent. The CBO says it’s just going to keep on rising.

But at some point, this increase must be limited. And limiting it is virtually impossible politically. The “right,” including a large segment of the donor class and their Congressional dependents, will not abide increases in taxes. Meanwhile, the “left” will not abide reductions in Social Security and Medicare that absorb much of the budget.

In other countries, like those in Scandinavia and other parts of Europe, where social support mechanisms are even more robust than in the United States, higher taxes pay for them. But solving the problem this way or reducing entitlements is well-nigh impossible in the U.S. for the foreseeable future.

If the U.S. can keep on manufacturing (i.e. “printing”) dollars, while somehow keeping inflation in check, it might be possible. But if interest rates on federal debt rise, as has been happening recently, then paying interest on the debt will become increasingly expensive.

Is the World Losing Faith in the Dollar?

In a May 28 article in the Financial Times, Bill Gross, the co-founder of Pimco, the largest bond manager in the world, who is considered an expert on the bond market, displayed graphs of the 30-year Treasury yield and the 30-year TIPS yield (Treasury Inflation-Protected Securities) over the last five years. The 30-year Treasury yield has increased by 3% since 2022. Lest one think this rise might be due to inflation, Gross also shows that the TIPS yield, which should cancel out the effect of inflation, has also risen by 3%. The only possible implication is that it is due to a loss of faith in the ability of the U.S. to ultimately pay its debts.

But TIPS yields have fluctuated before — not always for discernible reasons — so this may not be an ironclad explanation.

Yet Gross concludes that, because of the U.S.’s mandated obligations for healthcare and social security and the rising cost of defense, “guns and butter will continue to extend our global credit card to the limit, leading to the loss of one of its hegemonic necessities — a strong dollar.”

More to Consider

Eichengreen provides even more reasons for this possible result.

He begins by raising big questions that are on many people’s minds right now:

Challenges to rule of law at home and U.S. alliances abroad raise questions about the political foundations of dollar dominance. These factors have prompted foreign holders of dollars to reconsider their reliance on the currency, which in turn creates questions about its dominant international position.

Then he recounts the well-known advantages that have placed the U.S. dollar at the center of the global financial system: the US’s well-developed financial markets; dependable backstopping by the Federal Reserve; reputation of US Treasury securities as the most reliable investment, the “risk-free” investment; and the fact that markets for the exchange of most pairs of currencies are shallow, so it is usually less costly to use the dollar as a bridge to exchange currency for currency.

But then he asks:

How long will these advantages last? Will a rising competitor, such as China’s renminbi, finally gain parity or even ascendancy over the traditionally resilient U.S. dollar? And could economic decline or disaster lead to a collapse from which the dollar does not recover? These are open—and frequently asked—questions. One way of attempting to answer them is by tracing the arc of earlier international currencies.

This is the introduction to the central part of the book, which is the history of currencies over thousands of years, “from Croesus to Crypto,” as the book’s title says.

A Question of Currency

The history of currencies that Eichengreen presents is interesting. I remember vividly from my childhood Long John Silver’s parrot in the book “Treasure Island,” who repeatedly squawks “Pieces of eight!” But until reading Eichengreen’s book I didn’t realize that Spanish pieces of eight were the first truly global currency. This was due to Spain’s conquest of much of South America and the rich mines it was able to exploit there.

The city of Potosi, in present-day Bolivia, says Eichengreen, accounted for 60 percent of worldwide silver production. “The city swelled to a population of 200,000, larger than London and Amsterdam, despite its location at an elevation of 13,000 feet.”

There are many other pieces of the history of currencies in Eichengreen’s book, from those issued by the Greeks, to Alexander the Great, to Rome, to the Venetians, Amsterdam, and Spain, and finally England, until the American dollar.

Collapse or Slide?

But I did not really find in that history what Eichengreen seemed to presage in his introduction — historical examples of what might happen to the dollar in the present day. There were no examples of sudden collapse. Rather, the instances described are more in the nature of showing what characteristics allow a currency to cross international borders and become ascendant.

The waning of one currency and the ascendancy of another historically was mostly gradual. This might suggest that any replacement of the U.S. dollar is likely to occur incrementally, which is what most experts believe. And yet, in places Eichengreen implies that the danger of a run on the dollar is real.

For example, he says that while “The network effects of the dollar’s widespread international use still exert a strong gravitational pull…there may come a tipping point where agents move, en masse, to the currency of another country.” And, “it is still possible that U.S. fiscal and financial woes could push the dollar over the edge.”

In short, his prognostications about the fate of the dollar are much like the predictions you find about the future of the stock market. There may be a collapse! Or, it will continue to rise robustly!

Can the Dollar Be Replaced?

The challenges to the dollar need to be considered carefully. Eichengreen also mentions the overuse by the United States of financial sanctions, which have caused a number of countries — not only directly affected ones like Russia, China and Iran, but also European countries — to seek ways to avoid using the dollar. But the usual response to questions about whether the dollar can maintain its global role is, “You can’t replace something with nothing.”

This is true. Eichengreen considers several possible replacements for the dollar: the Chinese renminbi, the euro, and “a network of [state-issued] digital currencies—officially-sanctioned cryptocurrencies, if you will—issued by emerging-market central banks and traded on a dedicated digital platform, obviating the need to go through the dollar and U.S. banking system at all.” None of these alternatives are ready yet, nor will be for a long time.

The conclusions I reach from this book are that 1) It will be all right, but perhaps not for very long; and 2) the dollar might be in serious trouble if it continues to overreach.

Some people — even including some of the people who could cause that trouble — do not think this will necessarily be a bad thing.

But Eichengreen is not among them. He concludes, “there is little doubt that the benefits of the dollar’s international currency status swamp the costs. No other currency, now or in the foreseeable future, is positioned to fill the dollar’s shoes.”

Economist and mathematician Michael Edesess is an adjunct professor and visiting faculty at the Hong Kong University of Science and Technology. In 2007, he authored a book about the investment services industry titled The Big Investment Lie, published by Berrett-Koehler. His new book, The Three Simple Rules of Investing, co-authored with Kwok L. Tsui, Carol Fabbri and George Peacock, was published by Berrett-Koehler in June 2014.

A message from Advisor Perspectives and VettaFi: Discover something new! Click here to register for our upcoming webcasts.

Read more articles by Michael Edesess