The dominant role of the dollar in the international financial system survived the collapse of Bretton Woods in 1971 because there was no viable alternative. However, the crisis illustrated that the problem of a loss of confidence in the dollar due to a secular and seemingly irreversible accumulation of the United States net financial obligations to the rest of the world — known as the “Triffin Dilemma” — could reoccur.
To ensure the dollar’s role as a reserve currency, the U.S. would have no longer to maintain its stability through convertibility into gold but, like any fiat currency, through an implicit promise of continuous value stability for its holders, avoiding the uncontrolled growth of its net obligations to the rest of the world.
Since then, the dollar has maintained its hegemonic role as the primary currency in third-party transactions and, most importantly, in international financial transactions. This has happened even as the U.S. economy has lost relative importance – its share of global GDP shrank from 35% to 26% since 1971 – and, surprisingly, while generating a continuous current account deficit for more than five decades (meaning it has been investing more than it saves) with the cumulative deficit reaching 40% of U.S. GDP in 2008.
The accumulation of these persistent external deficits implies continuous U.S. borrowing from the rest of the world to finance domestic residents. Consequently, this has progressively eroded the U.S. Net International Investment Position (NIIP), the difference between the value of foreign assets held by American entities and the value of U.S. assets held by foreigners. This should have eventually undermined global confidence in the dollar’s stability.
However, this did not happen. The explanation for this sustained confidence in the dollar despite continuous external deficits lies in the appreciation of American assets abroad as a result of large direct investments made by major U.S. corporations since the post-war period and, more recently, equity investments in foreign stock markets. These assets have continuously grown in value relative to U.S. international obligations, which mainly consist of official holdings of U.S. Treasury bonds. This increase in the relative value of U.S. international asset portfolios nearly offset the accumulation of current account deficits, causing the U.S. NIIP, despite its secular decline, to reach a still manageable -5% of GDP in 2007.
However, since 2015, the tide has turned. As shown in the figure below, since 2010, the U.S. NIIP has plummeted to a staggering minus $24 trillion, or 82% of GDP in 2024, and continues to decline.
Part of this is still explained by the traditional American habit of saving less than it invests. Although the growth of current account deficits has slowed until recently, they have continued to accumulate significantly. However, the exponential increase in the NIIP is explained by the explosion in the relative value of dollar-denominated asset portfolios held by foreigners over the past decade, which already totalled $26.8 trillion in 2023, or about 97% of GDP.
This fast portfolio appreciation reflects, in part, the consolidation of U.S. global leadership in debt markets, as well as the secular appreciation of the dollar, which has gained 30% in real effective terms since 2008.
However, most of this appreciation comes from the spectacular performance of U.S. equity markets since the end of the Great Recession, raising the market value share of American companies to more than half of the global equity market, fueled by the rise of the “Magnificent Seven” the seven largest companies in the S&P 500, which now account for about 40% of the total value of the index. Additionally, the value of foreign assets held by Americans has grown relatively slowly, leading to a sharp increase in U.S. net obligations to the rest of the world.
These events have also had a significant impact on the composition of American assets in foreign investors’ portfolios. The chart below shows that, over the past ten years, the share of U.S. equities in foreign portfolios has increased from around 30% to more than 50%, now totalling almost twice the value of U.S. Treasury securities.
In the current scenario, marked by a power transition of great instability in Washington and a fragile U.S. macroeconomic balance, having this unprecedented level of net external debt, with 77% held by private agents, should raise concerns about the dollar’s future.
Under these conditions, it is crucial for the new administration to signal the only policy at its disposal to attempt to reduce the current account deficit: a rapid fiscal adjustment to curb the demand overstimulation inherited from the Biden administration, thereby reducing inflation and allowing for interest rate cuts that would put an end to the dollar’s appreciation.
However, the U.S. seems to have walked into a kind of Brazilian-style fiscal trap, where discretionary spending cuts by the Executive have become a small fraction of the total budget. Today, “untouchable” expenses such as Public Health, Social Security, Interest Payments, Defense, and Veterans Benefits leave only about $1.4 trillion available for cuts by the axe of the erratic DOGE of Elon Musk, clearly Trump’s bet to slash at least half of the $1.8 trillion deficit, to achieve the goal of bringing the deficit closer to 3% of GDP, as the new Treasury Secretary has signalled as necessary for adjustment.
If this silver bullet fails, Trump will have to pull another rabbit out of the hat, but he will be treading on thin ice regarding the dollar’s future, especially if he insists on pushing through his promised tax cuts while the economy is still digesting the chaos unleashed by the trade war he started.
Winston Fritsch is an economist with a long career in the private and public sectors. The author wishes to thank João Cottas for his help with this article.
