US debt and dollar dominance

The US has long defied conventional economic wisdom by sustaining persistent fiscal and trade deficits without triggering a dramatic sell-off in government bonds or a collapse in its currency.

This resilience is rooted in the unique position of the US dollar as the world’s dominant reserve currency, which allows the US to borrow at lower costs and attract global capital even as debt levels rise.

But there are growing risks that could gradually erode the dollar’s dominance. Geopolitical fragmentation, technological disruption (such as central bank digital currencies), loss of institutional credibility, and persistent fiscal recklessness could all undermine confidence in the dollar.

US debt: resilience, risks and future outlook

Over recent decades, the US economy has benefited from foreign capital seeking stable, high returns. Foreign economies with large trade surpluses, such as China and Germany, have recycled their excess savings into US financial markets. This global glut of savings has helped finance America’s twin deficits and kept interest rates low, enabling the US to borrow cheaply and spend beyond its domestic production capacity.

This dynamic has contributed to the US accumulating a debt-to-GDP ratio exceeding 100%. Recent fiscal policies, such as the ‘One Big Beautiful Bill Act’, are projected to increase deficits further, to around 7% of GDP over the coming years.

Despite the rising debt burden, interest rates have remained historically low. This apparent contradiction is explained by the structural demand for US dollar-denominated assets, which makes investors relatively insensitive to the scale of US debt.

Forecasts on the future trajectory of US debt-to-GDP are highly sensitive to a range of macroeconomic assumptions, including expectations for interest rates and real GDP growth. Even small deviations in these variables can materially alter debt sustainability projections. For example, a prolonged period of high interest rates could significantly increase debt servicing costs, while a productivity boom, perhaps driven by artificial intelligence, could boost growth and limit the debt burden.

US policymakers retain a range of tools, from structural reforms to monetary and fiscal strategies, to influence these outcomes and manage borrowing costs.

The US dollar’s global role

The US dollar’s status as the world’s primary reserve currency dates back to the Bretton Woods Agreement of 1944, which established the dollar as the anchor of the international monetary system. Even after the collapse of Bretton Woods in 1971, the dollar retained its dominance due to the size and liquidity of US financial markets, trust in its institutions, and geopolitical stability. Today, over half of global trade and cross-border financial claims are invoiced in dollars, and the dollar still accounts for 58% of global foreign exchange reserves. ¹

This privileged position confers several advantages:

1. Structural global demand for Treasuries: Foreign central banks and sovereign wealth funds consistently purchase US government bonds, keeping yields low.

2. Safe haven status: In times of global uncertainty, investors flock to US dollar assets, reinforcing demand and lowering yields when cheap financing is most needed.

3. Currency stability: The US can sustain trade deficits without triggering currency crises as foreign exporters reinvest their dollar earnings into US assets.

This arrangement has allowed the US to effectively decouple fiscal discipline from borrowing costs.

The US dollar’s multifaceted role in the global financial system, with each function deeply embedded in institutional trust, market infrastructure and historical precedent, makes any challenge to the dollar’s dominance a complex and gradual process.  

While central banks have slowly diversified away from the dollar since 2018, viable alternatives remain limited. The Chinese renminbi and the euro face significant structural constraints, while gold and cryptocurrencies are too volatile to serve as stable reserve assets at scale.

Recent market developments have sparked debate about whether we are beginning to see early signs of de-dollarisation, but investor behaviour remains the most immediate and sensitive barometer of confidence. Despite US dollar weakness throughout 2025, if investors were truly rejecting the dollar’s reserve status, we would expect a broader sell-off across US assets. The absence of such shifts suggests that the dollar’s reserve role remains intact. The dollar may be facing cyclical headwinds, but the structural dominance of liquidity, trust, and institutional depth continue to anchor investor behaviour.  

Do credit markets offer an alternative to the US dollar?

Despite concerns about US debt sustainability and the dollar’s reserve status, US fixed income markets remain structurally dominant. More than 80% of emerging market hard currency debt, global high yield, and securitised credit is issued in US dollars. Even for investment grade credit, more than 65% is dollar-denominated. This reflects not only historical inertia but also the depth, liquidity, and trust embedded in US capital markets.

Fixed Income Markets breakdown

As at 31 July 2025. Source: Bloomberg

The only meaningful diversification away from the dollar within fixed income has been in sovereign debt, but even here, US Treasuries represent roughly one third of the global government bond market. Alternatives, such as German government bonds, are much smaller and less liquid. Gold has seen renewed interest as a safe haven, but its volatility limits its role as a core reserve asset. Euro-denominated bonds offer some diversification, but fragmentation and limited scale constrain their utility.

For both the US dollar and US debt markets, a lack of viable alternatives tempers any immediate risk of a broad investor rotation.

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1 As at December 2024. Source: IMF