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Why the Dollar Still Rules - and Why That Is Unlikely to Change Anytime Soon

Is the US dollar going to lose its central role in international trade? Donald Trump’s economic policies, the increasing dominance of China in strategic sectors such as solar panels or batteries and the fracture of multilateralism triggered by the Russian invasion of Ukraine are only a few of the reasons cited in support of this thesis. The narrative is tempting.


Geopolitical fragmentation is not a new phenomenon: the U.S dollar has survived World War Two, the fall of Bretton Woods and the oil crisis in the Seventies without losing its dominance. This time U.S economic supremacy is seriously challegend by China, and technological advances may smooth out frictions in the currency exchanges, making it relatively easier to trade in other currencies. Yet despite all this, the dollar remains overwhelmingly central to international transactions. It dominates trade invoicing, cross-border finance, and global payment settlement—even in transactions that do not involve the United States directly.


To understand why this dominance persists, and why it is so hard to dislodge, one must move beyond clichés about American power or deep financial markets. The most convincing explanation comes from recent work by Abadi, Fernández-Villaverde and Sanches (2026), which reframes dollar dominance not as a reflection of static fundamentals, but as a coordination equilibrium—one that is historically contingent, self-reinforcing, and remarkably stable.


The Dollar as a Coordination Equilibrium

It all starts with a simple question: why did the pound sterling remain the dominant international currency well into the 20th century, long after the British Empire had ceased to be the world’s largest economy? If size, productivity, or even financial sophistication were sufficient explanations, the transition to the dollar should have happened much earlier.


The answer lies in coordination. A currency is useful internationally not just because it is backed by a large economy, but also because everyone else already uses it. A Thai exporter accepts dollars because she expects to spend them later; her suppliers accept dollars because their own suppliers do; and so on. Once such a system locks in, deviating becomes individually costly, even if alternatives exist.


This intuition is formalized in their paper through a mathematical model, then calibrated empirically. The paper shows that even very small frictions—on the order of a few basis points—associated with recognizing and using foreign currencies generate powerful strategic complementarities. When a currency becomes widely accepted, the incentive to hold and accept it rises further, reinforcing its dominance. The international financial system could work without a dominant currency, with actors holding different currencies according to their trade partner, but this equilibrium is fundamentally unstable. Just like a large rock sitting on top of a hill, small perturbation may make it roll out of its initial position into a more stable place. The international currency system naturally tips toward either a dominant-currency equilibrium or, less commonly, a multipolar one with a limited number of currency (e.g. euro, pound, renminbi and U.S. dollar) held by most players.


The implication is stark: dollar dominance persists not because U.S. fundamentals never change, but because coordination equilibria are sticky. History selects the currency, and once selected, inertia does the rest.


Why Size Still Matters

Fundamentals remain relevant. In the model, large economies enjoy a natural advantage because foreign agents expect more frequent trade with them, making it rational to hold their currency even if it offers lower returns. Size “begets dominance, and dominance begets persistence”. Fundamentals matter much more before dominance is established than after. Once the dollar is entrenched as the medium of exchange for global trade, even large shocks—declining U.S. trade shares, rising competitors, or policy mistakes—have surprisingly limited effects.


This logic helps explain why repeated predictions of dollar decline have failed. It also explains why the dollar is used so extensively in transactions with no U.S. counterparty at all, a phenomenon the paper labels a defining feature of a dominant-currency regime.


Tariffs, Trade Wars, and the Limits of Policy Shock

One might think that aggressive protectionism or trade fragmentation would undermine the dollar by reducing America’s role in global commerce. Abadi et al. (2026) test precisely this idea through “calibrated counterfactuals”. They impose permanent and reciprocal tariffs of 30 percent between the U.S. and the rest of the world—an extreme scenario both by historical standards and by today’s terms.

According to their calculations, even in such a dire situation, the dollar remains dominant. Trade with the U.S. falls, but the rest of the world continues settling transactions in dollars because that is what everyone else uses. History corroborates the result: both sterling and the dollar survived the protectionism of the interwar period without losing their international status.


The “Exorbitant Privilege”: Real, but Often Exaggerated

Any discussion of dollar dominance inevitably turns to the idea of the “exorbitant privilege”—the notion that the United States enjoys unique benefits from issuing the world’s dominant currency. In standard usage, the term refers to the U.S. ability to borrow cheaply, run persistent trade deficits, and earn higher returns on foreign assets than it pays on its liabilities.


In the calibrated model, the liquidity premium on dollar assets—the extra return foreigners are willing to forgo for the convenience of holding dollars—is there, but it’s smaller than many would anticipate at around 50 basis points at most. With a back-of-the-envelope calculation, one can say that about an amout of imports equal to 0.25 percent of U.S. GDP (80bn USD) is financed through this “privilege”. A real, but not huge amount.


This is an important corrective. Dollar dominance is not a magic money machine for the U.S., which still need to face every other country’s constraint in terms of debt sustainainability and financing, with just a little extra help from the “exhorbitant privilege”. Its primary benefit is systemic: it allows the U.S. to issue safe, liquid assets to the world and to absorb global demand for liquidity. The privilege exists, but it is modest and contingent on maintaining the institutional credibility that underpins dollar assets.


Could China or the Euro Dethrone the Dollar?

If tariffs and declining U.S. trade shares are insufficient, what about rising competitors? China’s capital account liberalization alone may do little to change outcomes. Even expanding payment infrastructure, such as China’s CIPS system, only elevates the renminbi to a secondary international currency. The incumbent’s coordination advantage remains overwhelming.


Only under aggressive and costly policies—such as dramatically lowering the liquidity premium on Chinese government debt—does the renminbi begin to rival the dollar. Even then, the model suggests coexistence rather than outright displacement.


The euro faces a different constraint. Despite the euro area’s economic size, its fragmented fiscal structure limits its ability to supply a unified pool of safe assets at the scale global markets demand. Coordination again matters: without a single, deep, and universally accepted euro-denominated asset, the euro struggles to overcome the dollar’s entrenched role as a medium of exchange.


What Would Actually Make the Dollar Lose Its Dominance?

If the dollar’s position is so stable, what could realistically change it? Abadi et al. (2026) point to shock large enough to break coordination as the only way in which the dominance may break. This may take a number of forms.


First, a sustained loss of institutional credibility—such as fiscal dysfunction that calls into question the safety of U.S. government debt—could raise the dollar’s liquidity premium enough to push users toward alternatives. Second, a geopolitical rupture that fragments the global trading system into rival blocs could support a multipolar equilibrium. Third, a technological or institutional innovation that dramatically lowers the cost of switching currencies might weaken network effects.


None of these conditions currently holds at sufficient scale. As the paper emphasizes, neither tariffs nor incremental competition meet the threshold. Until they do, the dollar remains locked in by history and coordination, not by nostalgia or inertia alone.


The Bottom Line

The dollar’s dominance is not a relic of Bretton Woods, nor a simple reflection of American economic might. It is the outcome of a coordination equilibrium that, once established, becomes extraordinarily difficult to dislodge. The “exorbitant privilege” that flows from this status is real but modest, and it does not guarantee permanence. Yet the forces required to overturn dollar dominance are far stronger than those typically invoked in public debate.


For now, the dollar remains what it has long been: not just a currency, but the default language of global commerce. And history suggests that defaults, once chosen, are rarely abandoned without a crisis big enough to force everyone to rethink them at once.


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