Strength Description Global Reserve Currency The USD is the primary reserve currency, held by central banks and financial institutions for international transactions and as a safeguard against economic instability. Economic Stability and Size The U.S. has the largest and most diversified economy, with strong legal and political frameworks that instill confidence in the USD, making it a safe haven during global uncertainty. Deep and Liquid Financial Markets The U.S. has highly developed and liquid financial markets, including the largest stock and bond markets, making the USD attractive for reliable investment prospects. Trade and Investment The USD is the preferred currency for global trade and investment, with many commodities priced in dollars and substantial foreign direct investment flowing into the U.S. Technology and Financial Industries The U.S. often leads in technology and finance, keeping the USD relevant and competitive in the global economy. Military and Political Influence The U.S. has substantial military and political clout, which helps keep the USD in use by allies and those in line with U.S. policies. Trust and Confidence The USD benefits from high trust and confidence due to credible U.S. monetary policy managed by the Federal Reserve. Network Effects The widespread use of the USD creates a self-reinforcing cycle of increased liquidity and utility, making it more attractive for future transactions and holdings. Even adversaries would face substantial problems should the USD face a crisis.

Weaknesses of the U.S. Dollar

The fundamental weakness of the U.S. dollar is that it is only valuable through government fiat. This weakness is shared by every other major national currency in the world and is perceived as normal in the modern age. However, as recently as the 1970s, it was considered a somewhat radical proposition. Without the discipline imposed by a commodity-based currency standard (such as gold), the worry is that governments might print too much money for political purposes.

One reason the IMF was formed was to monitor the Federal Reserve and its commitment to Bretton Woods. Today, the IMF uses the other reserves as a discipline on Fed activity. If foreign governments or investors switch away from the U.S. dollar en masse, the flood of short positions could significantly hurt anyone with assets denominated in dollars.

If the Federal Reserve creates money and the U.S. government assumes and monetizes debt faster than the U.S. economy grows, the future value of the currency could fall in absolute terms. Fortunately for the U.S., virtually every alternative currency is backed by similar economic policies. Even if the dollar faltered in absolute terms, it would still be strong relative to all other currencies.

Potential Threats to the Dollar’s Status

U.S. Fiscal and Monetary Policy

America’s fiscal and monetary policy can make the long-term purchasing power of the U.S. dollar uncertain. Large budget deficits of just over 6% of gross domestic product (GDP) and trade deficits of about 3% of GDP, funded by foreign investors through dollar-denominated securities, often raise concerns, especially with those critical of expansionary fiscal policy. Against gold, for example, the dollar’s purchasing power has fallen by 99% since 1972. If these imbalances grow and erode faith in the dollar’s future value, its status could be jeopardized.

The Federal Reserve’s unprecedented monetary expansion in response to recent economic crises, such as the 2008 financial crisis and the COVID-19 pandemic, has led to concerns about inflation and the dollar’s stability. The Fed’s balance sheet has ballooned because of massive asset purchases (quantitative easing) and low interest rates, which some argue could debase the currency over time.

If the U.S. continues to run large deficits and the Fed maintains an accommodative monetary stance for an extended period, it could lead to a loss of confidence in the dollar. Investors might fear that the U.S. will resort to inflation to erode the real value of its debts or that the dollar will depreciate significantly against other currencies.

Rising Strength of Foreign Currencies

While the dollar remains dominant, other national currencies are vying for a greater role in global trade and reserves. Despite challenges within the eurozone, the euro is the second most widely held reserve currency. The Chinese renminbi, bolstered by China’s economic might, is gradually gaining wider use, though it remains less than 3% of worldwide central bank foreign reserve currencies. Some central banks are also increasing holdings of the Japanese yen, British pound, and Swiss franc to diversify reserves. However, as you can see below, there has been no significant rise among any other leading currency in the past decade.

In addition, some countries are exploring bilateral trade in local currencies to bypass the dollar. China has currency swap lines with several nations to facilitate renminbi trade. The BRICS nations (Brazil, Russia, India, China, South Africa, and others) are discussing a shared currency. Rising powers may also forge new monetary alliances.

Moreover, countries facing U.S. sanctions, like Russia and Iran, are working to circumvent the dollar’s dominance. In response to sanctions, Russia has significantly reduced its dollar holdings and increased its gold reserves. It has also promoted using the ruble and other currencies for international transactions, particularly in the energy sector.

Efforts by Russia, Iran, and other nations to de-dollarize their economies and build alternative financial networks could, if successful, chip away at the dollar’s global dominance over time. They underscore how U.S. foreign policy, while powerful, can also give incentives to targeted countries to seek workarounds that could gradually erode the dollar’s universal standing.

Trade Wars and Geopolitical Tensions

Escalating trade wars and geopolitical tensions, particularly between the U.S. and China, could also threaten the dollar. If conflicts intensify and lead to a decoupling of the world’s two largest economies, efforts to reduce reliance on the dollar might be accelerated.

As America’s largest creditor and trading partner, China has significant leverage. In a worst-case scenario, China could dump its trillion-plus dollar holdings of U.S. Treasurys, sending shock waves through global markets. However, this would destroy the value of China’s own reserves and export-driven economy, making it a risky move to say the least.

More realistically, trade wars could spur China and other nations to hasten the development of alternative trade and financial channels that bypass the dollar. For example, China’s Cross-Border Interbank Payment System aims to internationalize the renminbi and cut its dependence on dollar transactions.

If trade friction splinters the global economy into rival blocs and alternative spheres of influence, it could fragment the monetary order and erode the dollar’s universality. Much depends on how the U.S. engages in economic and political diplomacy in a multipolar world. Finding a modus vivendi with rising powers while reassuring allies will be vital to maintaining global trust in the dollar amid geopolitical flux.

Fallout from the Global “Weaponization” of the Dollar

The dollar has become, in the words of some, America’s “weapon of choice” to further political objectives and preserve its global position. The U.S. has historically used dollar dominance to apply its policies and laws extraterritorially, undermine transactions contrary to U.S. interests (even if legal in other countries), exclude parties from dollar-based payment systems, and freeze or seize foreign dollar assets.

This runs the risk of making foreign institutions more reluctant to transact in dollars or hold dollar assets. Some countries are already reducing U.S. Treasury holdings, favoring alternative assets and trade arrangements. A shift away from dollars could undermine the U.S. ability to fund deficits, leading to higher interest rates and a devaluation of the dollar.

Can the U.S. Dollar Collapse?

There are conceivable scenarios that might cause a sudden crisis for the dollar. The most realistic is the dual threat of high inflation and high debt, a scenario in which rising consumer prices force the Fed to sharply raise interest rates.

Much of the national debt is made up of relatively short-term instruments, so a spike in rates would act like an adjustable-rate mortgage after the teaser period ends. If the U.S. government struggled to afford its interest payments, foreign creditors could dump the dollar and trigger a collapse.

If the U.S. entered a steep recession or depression without dragging the rest of the world with it, users might leave the dollar. Another option would involve some major power, such as China, reinstating a commodity-based standard and monopolizing the reserve currency space. However, even in these worst-case scenarios, it is not clear that the dollar necessarily would collapse.

The collapse of the dollar remains highly unlikely. Of the preconditions necessary to force a collapse, only the prospect of higher inflation appears reasonable. Foreign exporters such as China and Japan do not want a dollar collapse because the U.S. is too important a customer.

And even if the U.S. had to renegotiate or default on some debt obligations, there is little evidence that the world would let the dollar collapse and risk possible contagion.

What Would Happen If the U.S. Dollar Collapses? If the U.S. dollar collapses: The cost of imports will become more expensive.

The government wouldn’t be able to borrow at current rates, resulting in a deficit that would need to be paid by increasing taxes or printing money.

Inflation will spike because of the higher cost of imports and the printing of money, resulting in an overall accelerating collapse of the economy.

What Would Happen to My 401(k) If the Dollar Collapses? If the dollar collapses, your 401(k) would lose significant value. Exponential inflation would result if the dollar collapsed, decreasing the real value of the dollar compared with other global currencies, which, in effect, would reduce the value of your 401(k).

What Can Be Done Before the Dollar Collapses? Though the U.S. dollar collapsing is unlikely, ways to hedge against it include purchasing the currencies of other nations, investing in mutual funds and exchange-traded funds based in other countries, and purchasing the shares of domestic stocks that have large international operations.

Can Cryptocurrencies Replace the Dollar? Some have speculated that the rise of cryptocurrencies like bitcoin could impact the dollar’s status. While their role is limited, crypto may eventually gain traction as alternative stores of value or payment methods. However, despite their growth, cryptocurrencies remain highly volatile and lack the scalability, stability, and widespread acceptance needed to replace a significant fiat currency like the dollar. Their decentralized nature also poses challenges for large-scale monetary policy and financial regulation.

The Bottom Line

The commercial viability of the U.S. dollar is unchallenged. The dollar is used globally as a currency in worldwide transactions, most oil trades are done in U.S. dollars, and the country itself is the largest economy in the world and a politically and economically stable nation.

Some countries aim to de-dollarize or reduce their dependency on the U.S. dollar, but it is still essential for global business and is a widely held reserve currency. There is no reason to expect the U.S. dollar to collapse in the near future. Such a change would require the entire world to change its adherence to an international monetary system that has the greenback at its center. As yet, no replacement is anywhere on the horizon.