We are nearing the end of the dollar’s reign as the world’s reserve currency. The greenback has lost 11 percent of its value since the beginning of the coronavirus crisis. It may lose another 10 percent of its value this year.
The Federal Reserve lifted its key interest rate by a quarter of a percentage point on March 16 to combat inflation—into a range of 0.25 percent to 0.5 percent. At the same time, policymakers projected six more rate hikes this year. These moves should slow the inflation rate and economic growth by driving up interest rates on auto loans, credit card rates, mortgages, home equity loans and other borrowing.
Yet America has a much bigger problem than runaway inflation and rising mortgage rates. The federal debt load recently passed $30 trillion. Hence, interest rate hikes add billions of dollars to the sum America owes its creditors. Last year, the government paid $562 billion in interest—more than $1,500 for every man, woman and child in the nation. And it stands to pay much more than that this year if the Fed raises interest rates.
Today, nearly 60 percent of the $12.8 trillion in worldwide currency reserves is in dollars. This allows the U.S. to borrow cheap money since dollars are always in demand. But were the dollar to lose its reserve currency status, the federal government would no longer be able to borrow money cheaply. The interest payments on the national debt would consume a burgeoning portion of the gross domestic product.
This is one reason why financial historian Niall Ferguson warns that nations and empires often fall when the costs of servicing their debts exceed the cost of defending their borders. The U.S. is close to this tipping point and its rivals—like China, Russia and Saudi Arabia—realize this fact. So they are targeting the dollar.
Both China and Russia have been reducing their dependence on the dollar for bilateral trade since 2014. Some analysts predict that these powers will start dumping more dollars in retaliation against U.S. sanctions on Russia over the war in Ukraine. China, India and Russia are already exploring an alternative to the U.S.-dominated swift payment mechanism so they can continue trading with countries facing American sanctions. Such an alternative payment mechanism would be a significant blow to the dollar’s status as the world’s reserve currency.
Saudi Arabia is also talking with China about pricing some of its oil sales in yuan instead of dollars. Suppose China, India, Russia and Saudi Arabia stopped using the dollar. The greenback would become an isolated North American currency barely needed in the rest of the world. Banks would stop accumulating dollar reserves. The U.S. government would have to offer high interest rates if it wanted to sell treasury bonds to borrow money. It would have to enact high tax rates to pay the interest on those treasury bonds.
Currency war is on the horizon.