The fate of the US dollar and US exceptionalism

Chief Economist Eugenio J. Alemán discusses current economic conditions.

For all of those who follow our writings every week you know that we have fought hard to convince our readers, clients as well as advisors, that the preeminence of the US dollar is not in jeopardy (please refer to our previous writings on the topic or let us know if you need us to send you a copy of them). Many of the arguments exposed out there over the last 40 years (the length of our professional economist career) have had to do with conspiracy theories or pseudo-conspiracy theories with nothing behind them but, perhaps, the intention to take advantage of uninformed individuals or as an instrument to sell other products. Many times, these conspiracies also support scams and fraudulent activities.

The US dollar is one of the hundreds of currencies in the world and thus competes with other currencies for the services/benefits it provides to its holders. Thus, as is the case with any good/service, as long as the US dollar continues to provide services/benefits to holders of the currency, the US dollar will live alongside the country. We wrote a white paper where we talked about the functions of money that you can access here.

But the US dollar is, let us say, exceptional in many ways. For Americans, the US dollar is their currency, and, as we said above, as long as the US exists as a country, it will remain the currency of the US. That is, the US imposes the use of the US dollar within its territory. However, the US dollar is exceptional because millions of individuals, as well as firms across the global economy, also get services/benefits from holding US dollars. And we are not talking about US dollars being held at central banks across the global economy as part of central bank reserves. No, that is not what makes the US dollar exceptional. The most important characteristic of the US dollar as the preeminent currency in the world is NOT that it is one of the preferred currencies held by central banks as reserves, it is the fact that millions of non-US citizens and/or non- residents of the US, that is, foreigners, obtain services/benefits from holding US dollars.

Americans are obliged, by law, to use the US dollar; the rest of the citizens of the world are not. It is their choice, and as long as we keep the US dollar the most stable and trustworthy currency in the world, then the US dollar will have no competition in terms of the services/benefits it provides. For those who may be more skeptical about the US dollar exceptionalism, they probably want to use this saying: “in the land of the blind, the one-eyed man is king.”

Just to give a glimpse of what we are talking about, here is an extract1 from the Federal Reserve Bank of St. Louis from October of 2022 on the subject: “The rest of the world holds a great deal of U.S. currency, i.e., cash. Although the amount can’t be precisely tracked, the Federal Reserve Board of Governors recently estimated that foreigners held $950 billion in U.S. banknotes at the end of the first quarter of 2021, or about 45% of all Federal Reserve notes outstanding, including two-thirds of all $100 bills. Overall holdings of U.S. currency have grown rapidly, however, and overseas holdings of Federal Reserve notes would now be worth closer to $1.1 trillion if such holdings are still half of all U.S. currency.”

1Please see “The Innocent Greenbacks Abroad: U.S. Currency Held Internationally.” https://www.stlouisfed.org/on- the-economy/2022/oct/innocent-greenbacks-abroad-us-currency-held-internationally

Furthermore, the article continues, “Foreign holdings of U.S. cash also benefits Americans because those foreign users must get that currency by selling U.S. residents labor, goods, or services. If the cash never comes back to the U.S., then Americans have just exchanged pieces of green paper—which cost almost nothing to print—for valuable goods. This is a good trade for Americans. If the foreigner eventually uses the cash to buy goods and services from an American in the future—say in 10 years— then the foreigner has given America an interest-free loan for 10 years. This is also a good deal for Americans. The U.S. currency supply has increased rapidly in recent years to about $2.28 trillion in September 2022. If 45% of that is held abroad, foreigners are currently giving the U.S. government an interest-free loan of $1.03 trillion each year.” There is no other currency, i.e., or if you prefer, any other “one-eyed man” in the global economy that can provide these benefits/services as the US dollar can.

From the graph above, it is clear that during the last several months, the US dollar has depreciated somewhat as capital has started to leave the US, while the stock market has tanked due to the uncertainty created by the administration’s tariff policies. However, it is also true that the US dollar has appreciated considerably over the last decade or so, and it was probably due for some downward correction. But the depreciation of the US dollar is normal in a process of economic weakness, as the exchange rate, i.e., the value of the US dollar, is the shock absorber of the economy. Furthermore, what we have witnessed during the last several months is an economic shock, a shock engineered by, in some cases, punitive tariffs. Thus, this is just the normal functioning of markets and, in this case, the market for foreign exchange. On the flip side, the depreciation of the US dollar will be more effective in reducing the trade deficit than any proposed tariff, which typically have the effect of strengthening the US dollar. Please take a look at our Weekly Economics from April 11, 2025, for an explanation of the relationship between the US fiscal deficit and our trade deficit.

But for those holding the US dollar, the value of the dollar for one month, one year, or even several years is not what matters. What matters is that the institutions guarding the preeminence of the US dollar, i.e., the US Federal Reserve, remain in place and avoid politically related mismanagement, i.e., political party intervention, and continue to vouch for it over the longer term.

Federal Reserve independence: How important is it?

Perhaps one of the most important characteristics of the Federal Reserve (Fed) is that it is not a one-person shop. Furthermore, the Fed was created (and reformed) to withstand, as much as possible, any meddling by politicians. At the same time, the decisions are made by a group of highly talented and educated individuals.

Therefore, it would not matter if the president of the US fires the Fed Chairman. This is probably not going to change interest rate decisions by the board, but it will send shockwaves to the financial system, and it is a very risky proposition.

Members of the Board of Governors are not politicians and are not at the mercy of political cross currents. Being a member of the Board of Governors of the Federal Reserve or a Regional Fed Bank president is one of the most prestigious, if not the most prestigious, jobs there is for an economist or for a person in finance.

Of course, if the president fires all of the members of the Board of Governors and several Regional Fed Presidents, that’s another story. But the probability of this happening while not zero, is highly unlikely.

The preeminence of the US dollar is based on the ability of the Federal Reserve, the country’s central bank, to do whatever it needs to do to keep inflation low. Of course, inflation cannot be taken in isolation. Since the US dollar is part of a sea of currencies that compete for the services/benefits they provide individuals and firms, having a rate of inflation that is lower than that of other countries means that, in relative terms, the US dollar will remain king.

The US Supreme Court may be close to taking a case to decide whether the Trump administration can fire appointees despite federal laws that protect them if the government has no justifiable cause against them. If the US Supreme Court comes back saying that the administration can get rid of these officials and does not make any exceptions, i.e., for Fed members, it will put in jeopardy the independence of the Federal Reserve, threatening inflation and thus, the US dollar.

We want to be clear about this. The issue is not that a president could or couldn’t get rid of a high-level government appointee. The issue is the reason behind the decision. If a president wants to dismiss the Chairman of the Fed, and/or the rest of the Board/Presidents of the Fed because it disagrees with what is the best monetary policy to follow at any particular time, then the future of the US currency is in jeopardy and the preeminence of the US dollar may be at risk.

Central bank independence is one of the most coveted characteristics of any central bank across the world. It is a characteristic that is difficult to have and even more difficult to maintain over time. In fact, many central banks across the global economy have been the prey of politicians right and left, and this has enhanced the importance of the US dollar and has put the US dollar on top in terms of the services/benefits it provides to US citizens and foreigners alike.

Any politically motivated intervention to suppress an independent US Fed will send shockwaves through the global economy and threaten inflation and thus the preeminence of the US dollar in the global economy.

Economic and market conditions are subject to change.

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Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.

Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.

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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.

Employment cost Index: The Employment Cost Index (ECI) measures the change in the hourly labor cost to employers over time. The ECI uses a fixed “basket” of labor to produce a pure cost change, free from the effects of workers moving between occupations and industries and includes both the cost of wages and salaries and the cost of benefits.

US Dollar Index: The US Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the

U.S. dollar gains "strength" when compared to other currencies.

Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).

ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.

Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households.

Producer Price Index: A producer price index(PPI) is a price index that measures the average changes in prices received by domestic producers for their output.

Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.

The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.

Conference Board Coincident Economic Index: The Composite Index of Coincident Indicators is an index published by the Conference Board that provides a broad-based measurement of current economic conditions, helping economists, investors, and public policymakers to determine which phase of the business cycle the economy is currently experiencing.

Conference Board Lagging Economic Index: The Composite Index of Lagging Indicators is an index published monthly by the Conference Board, used to confirm and assess the direction of the economy's movements over recent months.

New Export Index: The PMI New export orders index allows us to track international demand for a country's goods and services on a timely, monthly, basis.

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Source: FactSet, data as of 12/6/2024