The Dollar’s Dominance is Eroding

When President Donald Trump unleashed sweeping tariffs on nearly all of the United States’ trading partners in April 2025, financial markets abandoned one of their traditional reflexes. Rather than rushing into the traditional safe havens of the U.S. dollar and Treasury bonds, investors sold them off.

In the three weeks following Trump’s self-described “Liberation Day,” the VIX index, which measures expected market turbulence (also known as Wall Street’s “fear gauge”), more than doubled. Yet instead of strengthening in the face of this uncertainty, the dollar dropped 6.5% against the euro. That marked a break from previous episodes of turmoil, including the 2008 financial crisis and the COVID pandemic, when investors piled into dollar assets.

The greenback is still the world’s dominant reserve currency and an important source of the United States’ geopolitical power. Yet new research by Arvind Krishnamurthy, a professor of finance at Stanford Graduate School of Business and a senior fellow at the Stanford Institute for Economic Policy Research, suggests investors are beginning to place less value on the dollar’s traditional status.

Krishnamurthy measures that status using the convenience yield — the lower return investors are willing to accept in exchange for the safety and liquidity of dollar assets. He finds that the premium has been shrinking since 2023.

The Trump tariff shock exposed an ongoing trend. “It was a surprise,” Krishnamurthy says. “The dollar and U.S. Treasury bonds have been safe havens, as good as gold. But last April, investors were dumping both.” The pattern is also visible in dollar repo markets, where financial firms borrow cash by pledging U.S. government bonds as collateral. The repo convenience yield has been dropping, suggesting investors are becoming less willing to pay a premium to hold dollar assets more broadly.

What if the erosion of the dollar’s special status continues? With Hanno Lustig at Stanford GSB, Zhengyang Jiang, PhD ’18, at Northwestern University Kellogg School of Management, and Robert J. Richmond at New York University Stern School of Business, Krishnamurthy models a scenario in which foreign demand for dollar assets disappears entirely. An obvious impact is that the dollar’s value would depreciate. Krishnamurthy’s model predicts that the dollar would depreciate by about 7.6% as foreign demand for U.S. assets disappears.

But that is only part of the story. A more significant consequence would be steeper borrowing costs. Krishnamurthy explains that foreign demand for “safe dollar debt” generates an economic benefit, much like exports generate revenue. That, he argues, is the chief value of reserve currency status: When everybody wants to stash their wealth in dollars, it drives U.S. interest rates down.

The $30 Trillion Prize

As foreign demand for U.S. Treasurys weakens, the government has to pay more to borrow, offering higher interest rates to entice American investors to absorb the debt. In Krishnamurthy’s model, borrowing costs rise by nearly a full percentage point as domestic investors absorb more Treasury issuance.

Lower borrowing costs, which economists call the “exorbitant privilege,” also help finance America’s persistent trade deficit. Yet that income dries up in Krishnamurthy’s model, falling from 0.9% of GDP to zero, while the gap between imports and exports evaporates.

This challenges a common assumption about what a weaker dollar would mean for the U.S. economy. It would make American exports more competitive, helping narrow the trade deficit. But Krishnamurthy argues that the benefits are outweighed by the higher borrowing costs that would ripple through America. “Losing reserve currency status does help the trade account,” he says. “But the effect of higher interest rates is orders of magnitude greater. If mortgage rates rose one percentage point, that’s a much bigger hit to the U.S. economy.”

None of this means the dollar is about to lose its position overnight. History suggests reserve currencies don’t collapse suddenly. “Losing reserve currency status is not like a bank run,” Krishnamurthy says. “You don’t wake up tomorrow and find it’s gone. The transition from the pound sterling to the dollar took a couple of decades and involved two world wars.”

Although the dollar recovered after last April’s sell-off, Krishnamurthy says the episode showed investors were willing to question assumptions that had held for decades.

Yet the dollar still benefits from one key advantage: It has no credible challenger. It still accounts for 57% of global foreign exchange reserves, according to the IMF, compared with 20% for the euro and just 2% for the renminbi.

That could eventually change. Yet reserve currencies are only replaced when another asset is capable of taking their place. “You need a competitor, and right now there isn’t one,” Krishnamurthy says. “That could change in one or two decades. And there’s a $30 trillion prize at stake.”