The dollar’s role in the fight for US primacy
Eight months into the second Donald Trump administration, the contours of its trade and exchange rate policies are becoming clearer—or at least their objective is. In line with the administration’s wider goal of reasserting the United States’ dominant global role, especially vis-à-vis China, economic policies have now become inextricably linked with US foreign policy priorities. The administration has deployed both its military and economic leverage in the service of its policy goals to a degree not seen for a long time.
With respect to China, the administration is taking steps to preserve and exploit US technological advantages, while trying to close the gap in other areas in which China has strategic advantages. The first category includes advanced chip design and artificial intelligence (AI), in which the United States continues to enjoy a slim advantage over China; the second category includes restoration of US manufacturing with the help of tariffs. Closing the manufacturing gap with China serves both domestic and international ends, of course, with the goal of boosting US employment while building the capacity to sustain a potential military conflict that would otherwise quickly exhaust the United States’ advanced weapons arsenal.
The administration aims to leverage new financial technologies as a source of growth and to keep the dollar at the apex of the world’s exchange rate system. Faced with the development of an internationally tradable Chinese digital currency that would operate outside US law, the administration aggressively pushed for Congress to pass the Guiding and Establishing National Innovation for US Stablecoins (GENIUS) Act to set up a regulatory environment for US dollar-backed stablecoins. From its point of view, staking out a crypto universe that consists largely of dollar-denominated assets could stifle Chinese plans and further underpin the United States’ economic leverage. Another advantage is that coin issuers would help finance the growing US deficit burden, as crypto firms have already become major buyers and holders of short-term Treasury securities.
At the same time, the administration has discarded important economic principles that, in medical terms, are equivalent to basic advice for a healthy lifestyle. For example, it has emphasized short-term growth by continuing with loose fiscal policies that add to already high debt, hollowed out government functions via across-the-board staff cuts, compromised market integrity by reducing regulatory oversight, appeared to interfere with statistical data collection, and sought to undermine the independence of the Federal Reserve. Formerly close allies and major trading partners are rethinking economic relations with the United States, given a climate of uncertainty in which disagreements in any policy area could trigger new tariff threats as a means of extracting further concessions.
Can the administration defy economic gravity?
These policies have been met with pessimistic—if not downright fatalistic—assessments of the future of the global economy and the international financial system, including in a recent Foreign Affairs edition and a Centre for Economic Policy Research e-book. The gist of these reactions has been that, by discouraging foreign trade and removing the cornerstones of the post-WWII economic order, the administration is: undermining the stability and productivity of the United States and other economies; and creating the risk of global instability, given economic interlinkages and the tight integration of financial markets. The biggest casualty of these developments might be the United States itself, given the inherent contradictions in a policy that aims to close the current deficit without improving public saving, raise productivity while sheltering firms from foreign competition, and cancel energy projects while electricity is urgently needed to feed a sprouting network of data centers—not to mention giving China the opportunity to boost its geopolitical standing as a trading partner and source of economic support for third-party countries.
And yet, the reaction of markets to this generational change in US policies has been remarkably muted. Stock markets have rebounded strongly after the April 2 tariff announcements and, even in the aftermath of the attempted dismissal of Federal Reserve Governor Lisa Cook, capital inflows into the United States have remained strong. The dollar and long-term Treasury markets have weakened in recent months, but these movements have been minor compared to the momentous policy reversals in recent months.
The momentum in technology stocks could well overshadow the consequences of recent policy changes, which will take some time to show their full effect. The picture would be much worse, however, had the United States and China not agreed to a truce in their trade dispute, with the United States refraining from further tariff measures in exchange for China’s continuing exports of rare earth minerals. Indeed, the dependence on China as a provider of these minerals presents a major constraint on the Trump administration’s latitude for further action.
It remains to be seen how markets will react to the possible release of pent-up inflation in the coming months, including from rising energy prices, the exhaustion of stockpiles of goods imported at lower tariff rates, and sectoral labor market shortages due to ramped-up immigration enforcement. A slowing economy might mitigate price pressures for some time, especially if there is a rise in unemployment among younger labor market cohorts, but it would be difficult to imagine these factors not reasserting themselves as long as the fiscal position is extremely loose.
If the administration were to respond by suppressing inconvenient data or shaping the Federal Reserve’s interest decisions, volatility could increase sharply. This risk still seems remote, but there is a real possibility of a fiscal doom loop due to a blowout of long-term interest rates caused by investors moving out of Treasuries, risking financial distress in case of unexpected market movements.
Currency dominance by default?
With these prospects, the debate about the future of dollar dominance is back in full swing. The risks of using the dollar would certainly increase if the Trump administration were able to directly influence monetary policy in the face of rising inflation (as happened, for example, under Turkish President Recep Tayyip Erdoğan in recent years, leading to overall negative outcomes).
It is important to keep in mind, however, that changes in global currency arrangements are not bound to happen overnight. Even in the case of large policy mistakes, the global role of the dollar might only weaken gradually, as it still seems unlikely that another dominant currency contender could replace it within a short time period.
A recent Atlantic Council strategy paper emphasized the link between global hegemony and reserve currency status, suggesting that only China, with its economic reach and geopolitical expansion, could possibly become a successor to the United States. Europe, meanwhile, is buffeted by powerful forces from the outside and within, ruling out a major geopolitical role for the euro in the foreseeable future.
However, China’s economic model is showing severe strains from adverse demographics, stagnant growth, and a large domestic debt overhang. Moreover, as China is a continental (rather than maritime) power, Chinese leaders have consistently stated that their strategic aims revolve around regional order and expanding trade and economic relations, rather than gaining global dominance. Another reason to be skeptical about the renminbi’s international use is that China’s capital account and financial markets are still tightly controlled and fairly closed to the outside. Moreover, the renminbi plays only a limited role as a store of value, given China’s lack of a stable and transparent regulatory regime and an independent judiciary.
Chinese authorities have refrained from liberalizing the capital account because of the risk that residents would invest substantial parts of their savings abroad for more attractive returns, leading to sharp capital outflows. This risk would, of course, diminish if the United States (along with other Western countries) were to end up in a debt spiral, but it still seems unlikely that the Chinese Communist Party would give up control over its citizens’ external transactions.
While this is obviously speculative, perhaps it will one day become possible for China to fully trace the participants and purposes of transactions in renminbi-based stablecoins, using its extensive surveillance capabilities in combination with sophisticated AI tools. This could allow further liberalization for foreign investors while keeping domestic capital controls in place. If China were also able to reassure foreign investors about their property rights and the rule of law, the renminbi could become more attractive as an investment vehicle, boosting its international use.
This thought experiment is just to show that we are entering uncharted territory. Eighty years after Bretton Woods, a new chapter of international finance is being written, in terms of both technology and the shared commitment to financial stability. The Trump administration supports this transition because it believes that earlier administrations did not respond forcefully enough to China’s misuse of global rules, to which it credits the country’s rise as a manufacturing power. The administration seems to hope that a tariff- and technology-driven boost will restore the US economy to the dominant position it once held.
With policies in flux, it is hard to predict how this paradigm change will play out. The United Kingdom at the end of the nineteenth century certainly did not expect the pound to be displaced by the dollar within a generation. Neither is it clear that there will be a dominant currency in the years to come. The alternative could be a multipolar, or even fragmented, global financial system with all the costs, uncertainties, and volatility that this could bring.
Stablecoins are no panacea
What seems certain, however, is that further cooperation between the large economies will be needed even if the administration succeeds in leveraging crypto technology to support the dollar’s global status.
The reason is that stablecoins will operate freely across borders, with different issuers competing for customers through a variety of incentives, which could include interest payments or the ability to obtain loans against their holdings. This is not allowed under the GENIUS Act, but other countries might be more lenient, or industry pressure might prompt changes to relevant legislation. However, the diversion of reserves by stablecoin issuers would increase the already nontrivial risk of a run by coin holders, which exists even under stricter regulatory standards.
The potential erosion of stablecoin discipline, as well as the consequences of stablecoins’ illegitimate use and susceptibility to cyberattacks, will require collaboration between regulators and monetary authorities of different jurisdictions. Unlike banks, stablecoins have no access to central bank balance sheets in case of distress, making it more difficult to inject emergency liquidity into the system. This further increases the risk of fire sales of the underlying assets—with potentially cataclysmic spillovers into the real economy.
For the same reason, it is clear that the United States must adopt responsible fiscal policies to support the primacy of global dollar-based stablecoins. Doubts about the value of the underlying asset would be a prime reason for investors to sell off their coin holdings. This is yet another reality that the administration will not escape. Crypto holdings can certainly help finance the deficit, but investors will take things into their own hands if the United States is unable to keep its public debt at reasonable levels.
To conclude, we could be at the cusp of an unprecedented change in the global financial landscape. The Trump administration looks to unshackle itself from what it sees as the constraints imposed on the United States by the previous global architecture. It seeks to preserve the dominance of the US dollar by means of stablecoins as one major advantage in its competition with China. Despite its unorthodox and controversial economic policies, it will need to realize that stablecoins offer no free lunch in the battle for geopolitical influence. Economic discipline and international cooperation must continue even under the envisaged paradigm change—a lesson that should be heeded before a crisis reminds us of it.
About the author
Martin Mühleisen is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and a former IMF official with decades of experience in economic crisis management and financial diplomacy.
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