The Tariff Gambit: Rhetoric, Reality, and the Road Ahead - Dollar Primacy (3/4)

September 2025 

Dollar as World Reserve Currency

Among the four key strategic challenges facing the United States, the shift in the dollar's role as the world's reserve currency stands out as both complex and significant. Transitioning to a digital currency framework could represent one of the most profound economic changes of our generation. This shift may have far-reaching effects on the U.S. economy, influencing everything from interest rates to the borrowing costs for both the government and businesses. If handled effectively, it could usher in a new era of American financial leadership. However, if mismanaged, it could trigger market instability and necessitate a major restructuring of the U.S. economy. For many years, the dollar's status as the global reserve currency has been a cornerstone of American prosperity. It ensures ongoing demand for U.S. Treasuries, which are preferred by central banks, sovereign wealth funds, and multinational corporations as secure and liquid assets.

That demand allows Washington to borrow more cheaply than it otherwise could, granting what Charles de Gaulle famously called an "exorbitant privilege": the power to finance trade and budget deficits in its own currency, which the rest of the world is compelled to hold.

But this privilege is not guaranteed. It rests on confidence, and confidence is fragile, especially in a period of disruption as significant as the shift to digital money. Markets offer little comfort in such moments. They rarely trade on fundamentals alone, but instead on allocations, crowd psychology, and the surges of capital in and out of assets. Expectations often matter more than numbers. A 5% interest rate can be bullish in one era and bearish in another. Every market peak has arrived at a different level of rates, a reminder that sentiment and capital flows outweigh arithmetic.

Against this backdrop, the structural anchor of U.S. risk remains its fiscal deficit. Federal debt has ballooned from $1 trillion in 1980 to more than $37 trillion today, with annual interest costs alone now exceeding $1 trillion. The pattern recalls the unravelling of Bretton Woods, a reference to the breakdown of the post-World War II international monetary system in the early 1970s. This historical event serves as a cautionary tale, reminding us that obligations eventually collide with reality.

The strain is compounded by slowing growth along the natural plateau of the economic "S-curve." Mature economies grow more slowly, yet America continues to borrow as if it were still an emerging power entitled to rapid expansion. This illusion of entitlement only deepens the spiral.

Two risks dominate the horizon: the self-reinforcing deficit spiral and the erosion of the dollar's reserve currency status. The latter is already visible. Since Western sanctions froze Russian-linked assets, central banks have accelerated their purchases of gold, an unmistakable signal of waning trust in the dollar as a long-term store of value. The dollar remains indispensable for transactions, but its role as the world's trusted anchor of savings is fraying.

Reserve status has never rested on gold or politics alone; it depends ultimately on the scale and dynamism of U.S. consumers. China understands this well. Its Belt and Road strategy is not just about ports, railways, and pipelines, but about cultivating a self-sustaining consumer ecosystem. This ecosystem, which includes a growing middle class and a robust domestic market, is capable of challenging the dollar's dominance after 2032. India, too, is poised to play a growing role in this re-centring of the global economy.

The greater danger, however, lies in second-order effects often ignored by U.S. policy. Tariffs may be helpful as bargaining tools, but when wielded as blunt instruments, they function as hidden taxes on consumers, raising prices, slowing growth, and undermining the very foundations of reserve status. Immigration curbs likewise constrict labour force growth at a moment when demographic headwinds are already pressing on the economy, further straining public finances. Even the much-celebrated promise of artificial intelligence carries risks if productivity gains accrue primarily to a narrow set of shareholders. At the same time, households remain burdened with debt, the consumer base that underpins dollar supremacy will erode from within.

If the dollar were to lose its reserve status, the consequences for U.S. debt would be nothing short of seismic. The first shock would hit demand. Foreign central banks, which today hold roughly $7 trillion in Treasuries, would begin cutting their exposure. As buyers retreat, yields would climb, pushing up the cost of borrowing. That leads directly to the second blow: interest costs. With annual debt service already above $1.1 trillion in 2025, even a modest rise in yields could tip the budget into a self-reinforcing spiral.

The third shock would be funding pressure. With foreign appetite diminished, Washington would lean more heavily on domestic investors and, inevitably, the Federal Reserve. That dependence opens the door to debt monetization, printing money to cover deficits, which fuels inflationary pressure. A weaker dollar would follow, raising the cost of imports and squeezing households with higher prices. To contain inflation, the Fed might be forced to lift rates further, making the debt burden even heavier.

The fallout would not stop at economics. If Treasuries lost their standing as the unquestioned "risk-free" asset, global reserves would diversify into gold, euros, yuan, or IMF Special Drawing Rights. The U.S. would also forfeit one of its most potent instruments of power. Washington's ability to weaponize finance, freezing Russia's reserves, for example, rests on dollar dominance. Without it, America's geopolitical leverage would fade.

History offers a cautionary precedent. The British pound reigned as the world's reserve currency until World War II. After losing that role, the U.K. endured recurring balance-of-payments crises, a suffocating debt load, and ultimately IMF bailouts in the 1970s. Britain did not collapse overnight, but its influence ebbed through decades of painful adjustment. For the United States, the scale would be far larger, and the consequences more profound.

The bottom line is stark: if the dollar were to lose reserve status, U.S. debt would become more complex and more expensive to finance, deficits would deepen, inflation would rise, and geopolitical clout would diminish. Which leaves a deeper question hanging: should America continue to enjoy the privileges of reserve currency dominance if it is unwilling, or unable, to meet the responsibilities that come with it? Reserve status rests not on financial engineering alone, but on the foundations of broad-based growth, fiscal discipline, and global trust. Without those pillars, the post-2030 world may not revolve around the dollar at all, but around China, India, and a new mix of digital and hard assets, from gold to central bank digital currencies to yet-undefined hybrids.

The Dollar's Enduring Privilege, and Its Fragile Foundations

Preserving the U.S. dollar's role as the world's reserve currency, or managing its gradual transition without severe disruption, may be the defining economic challenge of this generation. The story begins at Bretton Woods.

In 1944, as World War II drew to a close, the United States anchored the global monetary system by tying the dollar to gold at $35 an ounce. Other countries pegged their currencies to the dollar, secure in the promise that they could exchange those dollars for American gold. This arrangement effectively made the dollar "as good as gold", but it relied heavily on U.S. fiscal and monetary discipline.

Yale economist Robert Triffin saw the flaw early. To supply the world with liquidity, the U.S. had to run persistent deficits, sending dollars abroad. But the more dollars piled up overseas relative to American gold reserves, the less credible the gold promise became.

By the 1960s, Triffin's dilemma was a reality. U.S. gold reserves were dwindling, inflation was rising, and spending on both the Vietnam War and the Great Society outstripped revenues. France, under Charles de Gaulle, demanded gold for its dollars. Speculation mounted, the international "Gold Pool" collapsed in 1968, and faith in the $35 peg unravelled.

President Richard Nixon faced a choice between external discipline and domestic flexibility. On August 15, 1971, he chose the latter, suspending dollar-gold convertibility, imposing wage and price controls, and slapping a 10 per cent import surcharge. The "Nixon Shock" ended Bretton Woods and turned the dollar into a fiat currency.

From Crisis to Integration

The shift was destabilizing, but paradoxically, it deepened America's integration into the global economy. The dollar endured not because of gold but because of scale, credibility, and liquidity.

Today, roughly 90 per cent of all foreign-exchange trades involve the dollar. Around 60 per cent of official reserves are held in it, over 40 per cent of global trade is invoiced in it, and nearly 80 per cent of oil transactions are priced in it. Dozens of countries still manage their exchange rates around the dollar, making it the cornerstone of world commerce.

U.S. liabilities to foreigners are mostly low-yielding Treasury debt, while American assets abroad are riskier equities and direct investments that earn higher returns. When the dollar falls, foreign assets appreciate in dollar terms, boosting U.S. net worth.

This explains the paradox of income flows: despite a profoundly negative net international investment position (–$24 to –$26 trillion, nearly –85 per cent of GDP), the U.S. still earns more from its foreign assets than it pays out. China, by contrast, holds $3.3 trillion in overseas assets but often earns less than it pays because those assets are parked in low-yielding bonds.

In times of crisis, the asymmetrical nature of global finance often becomes more pronounced. A striking example of this was during the 2008–09 financial turmoil, when valuation effects alone generated a staggering $2.2 trillion windfall for foreign holders of U.S. assets. Although these gains were merely on paper, their impact was significant.

The supremacy of the U.S. dollar rests on several foundational pillars. One of the most critical is the scale and openness of U.S. markets, which allow for extensive commerce and investment. Additionally, the U.S. benefits from deep and liquid capital markets that consistently provide a supply of safe assets. These markets are bolstered by key factors such as legal predictability, strong creditor rights, effective contract enforcement, and the lack of capital controls—elements that enhance confidence among investors.

Moreover, the United States attracts a significant flow of human capital, including students, entrepreneurs, and investors, drawn by its world-class universities, innovative startups, and robust property markets. This influx contributes to the country’s economic vibrancy and competitiveness. As the dollar has established itself as the dominant currency for trade, settlement, and reserves, network effects come into play, making it increasingly difficult for rivals to dislodge its supremacy.

However, the dollar's position is not without its challenges, or "eroders." Inflation acts as a subtle form of default on foreign reserve holders, eroding the purchasing power of their assets. Furthermore, rising protectionism threatens to shrink the openness that underpins the dollar's strength, potentially accelerating the process of de-dollarisation. Fiscal excess can also undermine perceptions of U.S. Treasuries as the ultimate safe asset. As the rule of law weakens or as markets become more politicized, institutional slippage can occur, further diminishing trust in the U.S. financial system.

For any competing currency to challenge the dollar effectively, it would need to replicate the scale, openness, and institutional trustworthiness that the U.S. currently enjoys. At this moment, no other currency meets these criteria.

America now faces a policy dilemma as the costs of debt continue to rise. With annual interest payments surpassing $1 trillion, the options for addressing potential future shocks—whether they stem from wars, climate transitions, or political paralysis—are limited. The possible paths forward include austerity measures, financial repression, or outright default. More often than not, inflation emerges as the hidden lever, easing the burden of debt for the government but at the expense of creditors.

History offers sobering precedents. Spain, flush with New World silver, defaulted six times between 1557 and 1647. Britain, once the banker of the world, endured repeated balance-of-payments crises before turning to the IMF in the 1970s. Reserve-currency erosion is not sudden, but when it comes, it is unforgiving.

The dollar remains dominant, though its age is showing. Network effects, the scale of safe-asset supply, and institutional depth continue to reinforce its role. The convenience yield on Treasuries alone lowers U.S. borrowing costs by up to two percentage points, while crisis flows strengthen the dollar further. Altogether, this privilege generates annual benefits worth 0.5–0.8 percent of GDP.

Yet arithmetic is stubborn. Persistent deficits, swelling debt, and the temptation to inflate will keep testing the system. The challenge ahead is to sustain dollar primacy while managing the adjustments that must inevitably come, without stumbling into the sort of disorder that ended Bretton Woods.

The U.S. has also extended parts of its dollar machinery to the world. IMF quotas expand global liquidity, while Federal Reserve swap lines, peaking at $580 billion during the financial crisis and $450 billion in the pandemic, have become the most powerful tool. These backstops ease local funding strains, stabilise exchange rates, and compress arbitrage gaps. Their benefits extend well beyond the direct recipients.

But access is selective and political, and any broad expansion risks diluting the scarcity value of U.S. safe assets. Dollar primacy rests not only on privilege but also on careful stewardship. The margin for error is thinner today than at any point since Nixon severed the gold link.

Costs and Vulnerabilities of Dominance

The United States sits at the centre of the global financial system. It issues the world's dominant reserve currency, sets many of the rules for cross-border capital, and can, when it chooses, freeze or seize sovereign reserves. This "exorbitant privilege" has enriched America, allowed it to finance deficits cheaply, and sustained a broad network of allies. But privilege carries burdens. Financial dominance depends on military dominance, securing sea lanes, energy flows, and sanctions. A new Cold War with China or Russia could add up to $2 trillion annually in defense spending, straining already fragile fiscal arithmetic.

Hegemony also creates asymmetries. In crises, the dollar's strength cushions foreigners, while the U.S., as issuer, absorbs the most significant shocks by providing liquidity. Every time Washington weaponises the dollar, excluding rivals from SWIFT, freezing reserves, and sanctioning firms, it reinforces short-term power but accelerates long-term diversification. Alternatives are already advancing: RMB clearing, non-dollar networks, experiments with digital currencies.

This reality sits uneasily with the populist claim that the U.S. is "taken advantage of" in trade. America runs deficits not because it is weak but because the world needs dollars to function. Deficits are the mechanism by which the U.S. supplies global liquidity. Tariffs, therefore, are not a neutral "fix", they risk undermining the very system that magnifies U.S. power.

The danger lies in mistaking optics for strategy. Initial data suggested foreign exporters bore much of the tariff burden, but supply chains adjust. Costs eventually fall on U.S. households through higher prices. The endgame is slower trade, higher inflation, and a weaker dollar. If this coincides with the rise of alternative reserve assets, such as digital, gold-backed, or RMB-linked ones, the pillars of dollar supremacy could erode faster than expected.

The "MAGA turn" reflects a deeper shift: from empire to nation. By curbing trade, immigration, alliances, and aid, Washington is retreating from the open system that sustained dollar primacy. The strategy romanticises 1945, when U.S. factories were unrivalled. But in 2025, American power rests on financial centrality, not industrial dominance. Tariffs designed to revive a lost golden age risk backfiring, cutting vital inputs while encouraging partners to diversify away from the dollar. In the worst case, the U.S. could lose both manufacturing competitiveness and financial supremacy. Shakespeare's warning rings true: "For want of a nail, the kingdom was lost."

For others, U.S. tariffs and financial coercion serve as a Schelling Point: a clear signal to reduce dollar dependence. India, Vietnam, and others are increasingly settling trade in local currencies and accumulating gold instead of Treasuries. Without a single reserve at the core, trade balances more naturally, but at America's expense.

Tariffs also reveal the paradox of dollar power. On the surface, they reduce imports and strengthen the dollar. But retaliation shrinks U.S. exports and weakens demand for dollar invoicing. Capital flows mirror this tension: fewer imports mean fewer surplus dollars recycled into Treasuries, but global stress pushes investors back into U.S. bonds. Time and again, crises made in America end up financing America.

The U.S. international balance sheet complicates matters further. Tariff-driven stress strengthens the dollar, inflating U.S. liabilities in foreign terms while eroding returns on overseas assets. Persistent protectionism narrows the very income differential that sustains the paradox of "America owes more but earns more."

For now, network effects, dollar-centric invoicing, settlement, and collateral keep the system intact. But paired with sanctions and tariffs, incentives to build alternatives multiply. China's RMB invoicing push, CIPS, and gold-based settlement reflect the search for escape routes. Trust in America's openness, one of the five classic pillars of reserve-currency status, wanes when protectionism hardens into policy.

Fiscal arithmetic sharpens the risk. Tariffs raise revenue, but against $2 trillion deficits, the sums are trivial. Slower growth reduces receipts, worsening debt dynamics. For foreign holders of Treasuries, the combination of weak growth and rising debt undercuts confidence in America's safe-asset advantage.

History offers warnings. Sixteenth-century Spain squandered its silver windfall through protectionism. Britain's Imperial Preference system delayed but could not stop sterling's eclipse. The lesson is clear: tariffs may buy time, but they cannot sustain a hegemon's currency without openness, scale, and credible institutions.

The bottom line is two-sided. In the short run, tariffs may strengthen the dollar through safe-haven flows and reduced imports. In the long run, they corrode the trust and openness that make dollar primacy possible. Tariffs, in other words, are not a strategy but a stopgap, buying time while quietly weakening the very system they claim to defend.

Geopolitical Stakes and the Future of Money

Reserve currency dominance has always mirrored geopolitical supremacy. The dollar's rise after Bretton Woods was not just a monetary event; it was an extension of American power. China is now trying to follow that playbook, pairing renminbi internationalisation with real-economy expansion through the Belt and Road Initiative, RCEP, the AIIB, and large-scale infrastructure projects.

But the renminbi faces a structural hurdle. Actual reserve status requires open capital accounts, something Beijing resists in favor of tight control. Instead, China is betting on its digital yuan. At home, the CBDC accelerates the push to a cashless economy, ensures complete visibility of transactions, and gives policymakers tools like negative interest rates. Abroad, it is being positioned as a vehicle to expand the RMB's role in reserves, deepen Belt and Road ties, and bypass dollar-denominated settlement. Cross-border pilots with Hong Kong, the UAE, and Thailand already hint at that future.

This sets up a new front in the U.S.–China rivalry: digital sovereignty and payments infrastructure. Currency competition is no longer just about trade and debt but about who controls the rails of the global financial system.

Meanwhile, the dollar-centric order is showing late-cycle strain. The Fed's dovish tone collides with sticky inflation, a weakening labor market, and housing demand propped up by builder incentives rather than real affordability. Households are under pressure: credit-card delinquencies are climbing at record speed, and "buy now, pay later" services are increasingly used for groceries, a sign of necessity, not choice.

The informational environment is equally fragile. Official statistics have become politicized and frequently revised, while data agencies face leadership churn and shrinking analytical capacity. Policymakers and markets alike are being forced to "fly blind."

All of this puts the foundations of reserve currency status under sharper scrutiny. A reserve asset must do three things: provide liquidity for payments, manage risk prudently, and deliver reasonable long-term returns. For now, nearly 80% of global reserves remain in U.S. dollars and euros, concentrated in government bonds. But confidence in that system is no longer unchallenged.

The basic functions of money, medium of exchange, unit of account, and store of value, have long been served by state-backed fiat. That foundation is now shifting. Central bank digital currencies (CBDCs) are being designed to carry those same functions into the digital age. Their strength lies in government backing, integration with central banking systems, and lower volatility than cryptoassets. The trade-off is privacy: every CBDC transaction embeds data, raising concerns over surveillance and sovereignty.

The IMF's "money tree" framework highlights how CBDCs diverge from crypto or stablecoins: claims on the state versus private issuance; fixed redemption versus floating value; public guarantees versus private risk; centralised versus decentralised tech. Crypto's volatility and lack of a backstop make it unreliable as money. CBDCs, by contrast, are engineered to solve precisely those weaknesses.

But CBDCs are more than monetary tools; they are geopolitical instruments. Currency issuance has always symbolised sovereignty; CBDCs extend that symbolism into cyberspace. Financial data itself is now treated as a national security asset. A breach of a CBDC system could be read as a violation of sovereignty.

The U.S. has been slow to act, comfortable in the "exorbitant privilege" of the dollar and reliant on sanctions as policy tools. China has moved faster, using its digital yuan to expand influence across its economic orbit. Europe is testing a digital euro. Washington may eventually be forced into a "space race" of its own.

The U.S. is already responding through policy. The bipartisan Genius Act aims to establish America as the hub for regulated dollar stablecoins. The model is clear: require reserves in cash or T-bills, put issuers under federal licensing and OCC-style supervision, and, in return, channel demand for safe digital dollars into Treasuries.

Stablecoins, in this vision, are not a threat to the dollar but an extension of it. They export dollars through smartphones instead of bank branches. Two models are emerging:

1.     Domestic rails: USDC powering on-chain payments, escrow, refunds, and fraud prevention.

2.     Offshore savings vehicle: Tether (USDT) serving as a eurodollar-like dollar deposit for the unbanked and emerging markets.

If supply scales to $3–4 trillion by 2030, stablecoins could become structural buyers of Treasuries, anchoring U.S. borrowing costs and reinforcing the dollar's network effects.

The institutional shift is already visible. JPMorgan has launched tokenised deposits on Base. BlackRock now frames Bitcoin as a "risk-off" asset alongside gold and Treasuries. Coinbase and Robinhood are racing to build crypto super-apps that blend payments, custody, and trading.

Stablecoins are not the only front. Real-time payment systems are transforming domestic finance and will soon cross-border flows. India's UPI has become the global benchmark, processing 20 billion transactions worth nearly ₹25 lakh crore in August 2025 alone. Brazil's Pix has reached 76% adoption, handling $5 trillion in annual value, already larger than cards. Mexico's SPEI, Europe's TIPS, and Africa's mobile money systems point in the same direction.

The next step is interoperability. Corporations and banks will demand instant, low-cost global flows across UPI, Pix, SWIFT, CBDCs, and stablecoins. Institutions that cannot stitch these rails together will fall behind.

These innovations play out against a multipolar backdrop. BRICS now account for more global output in PPP terms than the G7. China and India together are projected to generate one-third of world growth through 2028. Trade and reserves are diversifying: 90% of China–Russia commerce now bypasses the dollar, and central banks are hoarding gold at record levels. The dollar still dominates, but its share of global reserves has slipped from 70% in 2000 to under 58% in 2024.

What's emerging is not the end of the dollar but the rise of a plural financial order. Instead of a single hegemon, we are moving toward a system where multiple instruments, CBDCs, stablecoins, real-time payment networks, tokenised ETFs, and BRICS-led commodity-backed initiatives coexist, overlap, and sometimes compete. This isn't fragmentation for its own sake; it's the natural evolution of finance in a world that is both digitally interconnected and geopolitically fractured.

In cricket analogy, this is where it gets tricky. We are on a turning subcontinental track, where the bounce is uneven, reverse swing shows up without warning, and the conditions change session by session. Success will depend less on brute force and more on adaptability: reading the pitch, rotating the strike, knowing when to defend and when to attack. The financial players who mistake this new phase for a continuation of the old order will be bowled out cheaply. Those who adjust to the conditions, innovating without losing their footing, will still be at the crease when the game enters its decisive overs.