Shortly after the Russian invasion of Ukraine in 2022, the U.S. Treasury ejected a number of Russian banks from the SWIFT (Society for Worldwide Interbank Financial Telecommunication) messaging system and seized hundreds of billions of dollars worth of Russian-held U.S. dollar assets. Since then, the dedollarization trend has become a perennial topic in financial and economic circles. Anchored by the ten BRICS nations, efforts are underway to diversify away from the dollar, which has stood as the global reserve currency since the Bretton Woods agreement concluded in 1944. The U.S. dollar has retained its role as the center of gravity of global commerce despite wars, the loss of its link to gold in 1971, the rise of competitors, economic downturns, and other challenges. A recent blow to the dollar’s prestige has been the cavalcade of Federal Reserve pandemic policy errors, which include massively expanding the money supply in 2020, ignoring the outbreak of inflation by dismissing it as “transitory,” raising interest rates so rapidly that a handful of regional banks were destabilized, and now — quite possibly — not having raised rates sufficiently. The general price level is continuing to rise at rates nearly twice the Fed’s target range.
Recent data shows that dedollarization is indeed proceeding, but at a very slow pace. And that makes sense: the world is accustomed to doing business in dollars. Barriers to exit are high, owing to long-established financial institutions both formal (technology, accounting systems, and terms of settlement) and informal (customs and habits). All contribute to the deep entrenchment of the buck in global trade networks. But international reserve currencies have come and gone throughout history: the U.S. dollar replaced the British pound, which itself replaced the Dutch guilder, and so on.
The loss of the dollar’s reserve status, whether it takes years or decades, is likely to have severe consequences for both U.S. citizens and the government. Declining use of the dollar would result in a depreciation in its value, driving up the price of imports. A secondary effect of falling international use of the dollar would be a diminished source of interest in the U.S. Treasury securities, in which dollar reserves are invested. Given Washington D.C.’s increasingly insatiable (and bipartisan) appetite for spending, policies likely to lead to declining bidders for U.S. bills, notes, and bonds, as well as higher interest rates for those instruments, should be of concern. Questions are already being raised by credit rating agencies regarding the impact of trillion-dollar budget deficits, and tens of trillions of dollars of U.S. government debt on future U.S. economic growth and fiscal sustainability.
Yet a host of novel threats to the resilience of our longstanding financial cornerstone have emerged. Whether owing to a lack of understanding or the time-honored political habit of sacrificing tomorrow for today, the dollar’s centrality is as much at-risk from domestic as foreign sources currently.
Take the Biden administration’s March 11, 2024 General Explanations of the Administration’s Fiscal Year 2025 Revenue Proposals. Buried on page 80 — in a footnote — is the following blurb:
A separate proposal would first raise the top ordinary rate to 39.6 percent (43.4 percent including the net investment income tax). An additional proposal would increase the net investment income tax rate by 1.2 percentage points above $400,000, bringing the marginal net investment income tax rate to 5 percent for investment income above the $400,000 threshold. Together, the proposals would increase the top marginal rate on long-term capital gains and qualified dividends to 44.6 percent.
Combining state and federal taxes, the top marginal U.S. long-term capital gains tax rate currently ranges from 20 to 33 percent. Under the FY 2025 budget proposal, the combined long-term state-Federal capital gains tax burden would surpass 50 percent in numerous states.
That would significantly raise, and in some cases double, the tax burden in epicenters of corporate and multinational headquarters including California (to nearly 60 percent), New Jersey (to just over 55 percent), and New York (to over 53 percent).
Part of the appeal of the U.S. dollar as a reserve currency is the presence of liquid, deep, and broad capital markets; not just in U.S. government securities but in equities, corporate bonds, and other investments. Governments and large corporations with large dollar holdings frequently invest those reserves, and often in U.S. Treasuries. The current weighted average maturity of U.S. Treasury securities outstanding is roughly 72 months, or six years: long enough that materially altering the tax code where long-term investments are concerned is likely to substantially alter investor behaviors. It’s more than a confiscatory measure being levied by a nation increasingly unable to live within its means. The imposition of the highest capital gains taxes on investment in over a century conveys open hostility to would-be investors.
Elsewhere, economic advisers to former President Trump are said to have recently discussed directing punitive measures against nations shifting their currency usage away from the U.S. dollar. Saleha Mohsin of Bloombergreported last week that trade restrictions, tariffs, and penalties typically associated with currency manipulation are under discussion. As with a gargantuan increase in capital gains taxes, the very consideration of threatening punitive measures against countries increasingly convinced of the vulnerability of engaging in dollar-based commerce implies a lack of awareness bordering on inscrutability.
The oft-heard argument that there are no substitutes for the dollar does not ring true in an era of stablecoins, central bank digital currencies, and rising commodity prices. The recent bull market in gold has been in part driven by central banks diversifying away from the dollar and bracing for geopolitical uncertainty.
Drafting the U.S. dollar, America’s long-dominant global reserve currency, into foreign military service over Russia’s invasion of Ukraine was a fateful decision. It’s one that U.S. citizens and policymakers alike will have to live with the consequences of for decades. The least we can expect from U.S. public officials now is to not to exacerbate current trends by engaging in irresponsible, short-sighted policy suggestions which, while grasping for ideological points, further impair the utility of the dollar. And in so doing, confirm global suspicions about Washington D.C.’s increasing disconnection from economic reality.
