About the author: Dan Katz is co-founder at Amberwave Partners, an asset management firm, and former senior advisor at the U.S. Treasury, 2019-21.
The U.S. dollar’s status as the world’s reserve currency gives the United States a financial superpower—the ability to impose costs on adversaries through sanctions. But the use of that superpower in recent years has driven fears that other countries may move away from using the dollar to minimize their vulnerability to sanctions. Such a shift would endanger many benefits the U.S. receives from dollar hegemony, beyond just the ability to impose crippling economic sanctions.
Yet dollar dominance is not a zero-sum game. In reality, U.S. sanctions are a fundamental part of the series of tradeoffs that create a stable equilibrium of dollar use in the global economy. Over the long term, U.S. sanctions are a key pillar of, not a threat to, dollar dominance.
Foreign countries’ use of the dollar for reserve assets and as a transaction medium brings vulnerability to sanctions, but also a litany of benefits. Governments and private actors’ evaluation of the costs and benefits of the dollar system, including potential sanctions, shapes market usage of the dollar.
Different economies have different incentives for dollar adoption. For example, developing countries like Colombia or Kenya that run current account deficits must import foreign capital; therefore, their growth depends on providing assurance to international investors that their investments will not be threatened by hostile action or subject to expropriation. In these cases, countries that accumulate dollar reserves tacitly signal to foreign investors that their investments are safe, because these governments would be vulnerable to U.S. sanctions in the event of bad behavior. As Michael Dooley, David Folkerts-Laudau, and Peter Garber have argued, reserves should be seen not as U.S. liabilities, but as a form of public collateral for Western investors.
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Many developing countries will eagerly expose themselves to the risk of sanctions in exchange for accelerating integration with the West. Sanctions strengthen the credibility of the commitment not to confiscate private investors’ assets, engendering more confidence, more global capital flows, and more secure reserve status for the dollar.
As current account deficit countries move up the development curve, many, like China, have transformed into current account surplus countries. These countries’ excessive productive capacity and savings create a different set of considerations for dollar access and therefore, sanctions vulnerability. Surplus economies derive a wide range of benefits from dollar usage. For example, they require a large consumer market willing and able to absorb their excess productive capacity and savings. If they were forced to recycle savings domestically, their currencies would appreciate significantly, slowing their export-driven economies. Additionally, they also need to import Western technology and, critically, must sell to deficit countries, which are incentivized to use the dollar. Exposure to sanctions is a price they pay in exchange for accessing these direct benefits of participation in the dollar system.
Dollar hegemony is an equilibrium that results from a complex balance of costs and benefits for all international participants—including the U.S. For Americans, the dollar’s international role brings real benefits like seigniorage—one time profits made by exchanging newly created dollars for real goods or services—but also harmful incentives for Americans to consume more than they produce and to offshore supply chains, diminishing resilience. It’s always been implicit in the bargain that the U.S. will accumulate economic leverage that it can use through sanctions.
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Economic data on the dollar’s international use support the conclusion that U.S. sanctions are a fundamental part of the equilibrium that has put the dollar at the center of the international economic system. U.S. sanctions have dramatically increased in frequency and severity over the last decade, but the dollar’s share of reserve assets has been relatively consistent at approximately 60% since 2008, with most changes due to fluctuations in valuation. Even more poignantly, the dollar’s share of international transactions was 88% in 2022, up from 85% in 2010. Despite loud complaints about U.S. sanctions, the evidence suggests that the dollar system remains attractive on net for all parties.
As long as the U.S. remains the most dynamic large economy, with the deepest and most liquid financial markets, world leading innovation, rule of law, and unrivaled influence over the international security architecture, the dollar’s international role will likely persist. Indeed, if the U.S. did not stand prepared to use sanctions to advance its national interest, faith in its ability to continue to stand at the center of global affairs could be undermined, weakening dollar hegemony.
Sanctions are increasingly the foreign policy tool of first resort, in part because they are perceived to entail minimal domestic cost. This dynamic has its problems. It creates incentives both to reflexively reach for sanctions in an urge to appear to be taking action when restraint would prove more prudent, and also to rely on sanctions at the expense of other policy tools, including harder forms of power, that are critical to maintaining the dominant U.S. geostrategic position over time. If sanctions pose any threat to the dollar, it is from ineffective use that undermines America’s security standing, not from an active and considered approach.
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