King Dollar

Dominance, Privilege, and the Conditions of Decline

Three recent analyses of the dollar’s international role — by Paul Krugman, Barry Eichengreen, and Pierpaolo Benigno — converge on a surface agreement that dollar dominance is not about to end, while diverging sharply on why it persists, what threatens it, and what its loss would cost.

This post argues that the three perspectives are not competing so much as operating at different analytical levels:

• Krugman addresses the short-run economics of network effects and incumbent advantage;

• Eichengreen addresses the long-run institutional prerequisites that underpin reserve currency status; and

• Benigno addresses the conditional mechanisms through which dollar dominance manifests under stress.

Integrating the three produces a picture more nuanced and more troubling than any of them individually conveys.

The dollar is not at imminent risk. But the conditions that have historically preceded reserve currency decline are being created with unusual speed, and the safe-haven mechanism that has reliably reinforced dollar dominance in past crises may function less predictably when the United States itself becomes the primary source of global economic uncertainty.

I. The Anatomy of Dollar Dominance

To assess the dollar’s future, one must first understand precisely what the dollar does. Krugman’s framework — drawing on a Federal Reserve synthesis by Bertaut, von Beschwitz, and Curcuru — is the most systematic account.

The dollar is not merely a currency; it is the currency of currencies. In foreign exchange markets, it is involved in 88 percent of all transactions — a share that far exceeds the United States’ share of world trade.

When Brazilian businesses trade with Malaysian counterparts, negotiations proceed in English and contracts are denominated in dollars, not because anyone mandated these choices but because that is where the large, liquid markets are.

The dollar is the world’s dominant vehicle currency, its primary reserve asset, the dominant medium for trade invoicing outside Europe, and the dominant denomination for cross-border debt. By any composite measure, no rival comes close.

The self-reinforcing logic of this dominance is the most important analytical point for understanding both its resilience and its potential fragility.

People use dollars because others use dollars; businesses price in dollars because other businesses price in dollars; central banks hold dollar reserves partly because dollar markets are the most liquid, and those markets are liquid partly because central banks hold dollar reserves.

Krugman, following a tradition he traces to Charles Kindleberger’s 1967 paper on international money and world language, draws the analogy to English: just as non-English speakers negotiate in English because it is the common language of international commerce — not because any global authority requires it — the dollar is used in transactions that have nothing to do with the United States because it is where the coordination has already happened.

Displacing the dollar would require not simply the emergence of a better alternative but a simultaneous coordination shift among thousands of independent actors. That is a very high bar.

Eichengreen traces the preconditions of this dominance to a longer historical lineage — the Florentine florin, the Dutch guilder, the British pound — and identifies five prerequisites: quality assurance, commercial prowess, a sophisticated financial system, political checks and balances, and geopolitical security for the issuer.

What makes his analysis distinct from Krugman’s is not disagreement on the current facts but a different temporal frame of reference.

Where Krugman asks whether the dollar will lose its dominance soon, Eichengreen asks what conditions must be sustained for it to remain dominant at all.

His Roman analogy is not a prediction of imminent collapse but an illustration of mechanism: the denarius remained the world’s dominant currency long after the institutional rot that eventually destroyed it had begun. Network effects preserve incumbency even as the foundations deteriorate.

II. The Exorbitant Privilege — How Large Is It?

The question of what dollar dominance is actually worth to the United States has been debated since Valéry Giscard d’Estaing coined the phrase “exorbitant privilege” in the 1960s.

Krugman performs a useful service by deflating the more extravagant claims. The assertion that dollar dominance gives the United States a unique ability to run sustained trade deficits is demonstrably false: Australia has mostly run, sometimes large, current account deficits since the 19th Century without reserve currency status, and the United Kingdom has done so continuously since 2000.

Nor is there clear evidence that the dollar’s status allows the United States to borrow at significantly lower rates than it otherwise would — Ben Bernanke examined this proposition and found no robust evidence supporting it.

The more sophisticated versions of the exorbitant privilege argument — Hélène Rey and Pierre-Olivier Gourinchas on the United States as a “hedge fund nation,” earning high returns on risky foreign assets while issuing safe low-yield liabilities — have more analytical traction, but the magnitudes remain contested and partly obscured by multinational tax avoidance that inflates apparent US returns on foreign investment.

The conclusion, which Krugman reaches, is that even if dollar dominance makes the United States somewhat richer, the effect is not transformative relative to the scale of a $31 trillion economy.

The privilege that does appear to be large, and that Krugman rightly identifies as more important than the financial one, is political: the ability to weaponize the dollar’s infrastructural role in global finance.

Because most cross-border transactions run through dollar-clearing systems that touch US correspondent banks, US authorities can observe and in many cases block transactions that have no direct American party.

Henry Farrell and Abraham Newman’s “Underground Empire” documents this power extensively, with Iran sanctions as the prime exhibit.

This is not an abstract power. It is the mechanism through which the United States has been able to enforce its foreign policy preferences on third-country actors who want nothing to do with American domestic politics.

The loss of dollar dominance would not merely reduce American wealth at the margins; it would fundamentally alter the coercive capacity of American statecraft.

III. The Conditional Safe Haven — Benigno’s Critical Contribution

The most analytically novel contribution to the current debate comes from Benigno, whose empirical work on five decades of uncertainty shocks identifies a feature of dollar safe-haven status that neither Krugman nor Eichengreen fully engages: it is conditional, not permanent.

The baseline result is familiar and confirmed by the Iran war experience: when financial stress spikes, as measured by the VIX, the dollar appreciates. The mechanism is well-understood.

Trillions of dollars in offshore liabilities are denominated in US currency. When stress peaks, institutions that have borrowed in dollars scramble to acquire them, producing a dollar shortage that drives the exchange rate up.

This dynamic was visible in the acute phase of the Global Financial Crisis, during the March 2020 Covid shock, and again in the opening weeks of the Iran conflict. The dollar strengthened precisely when it was supposed to.

But Benigno’s finding on the origin of the shock complicates the standard narrative significantly.

When uncertainty originates in US economic policy — fiscal brinkmanship, regulatory reversals, trade-war escalation — the dollar tends to weaken rather than strengthen.

The two forces that normally reinforce each other — flight to safety and flight to the US — pull in opposite directions when America is the source of the problem rather than the refuge from it.

The Economic Policy Uncertainty index produces a fundamentally different dollar response than the VIX, and this distinction is precisely what the current period requires us to understand.

The Iran war is a geopolitical shock that strengthens the dollar through the standard safe-haven mechanism. The tariff escalation, the debt-ceiling brinksmanship, the threats to Federal Reserve independence — these are US-origin shocks that weaken it.

Both are occurring simultaneously, and their interaction cannot be read from either mechanism alone.

The most penetrating observation in Benigno’s analysis is his final one: the safe-haven mechanism may contain the seeds of its own erosion.

Every dollar squeeze during a crisis — every episode in which dollar appreciation tightens financial conditions in emerging markets, raises the cost of dollar-denominated debt service, and forces painful balance-of-payments adjustments on countries that had nothing to do with the crisis — strengthens the incentive to reduce dollar dependence.

The construction of swap lines, local currency invoicing agreements, BRICS settlement systems, and alternative payment architectures is slow, expensive, and technically complex.

But each crisis that demonstrably punishes dollar dependence adds urgency and political will to that construction project. The mechanism that makes the dollar indispensable in crises is the same mechanism that motivates the world to make it less indispensable.

IV. What Would Actually Dethrone the Dollar?

Krugman is surely correct that Iran’s Hormuz toll policy — demanding payment in yuan or cryptocurrency rather than dollars — does not constitute a structural threat to dollar dominance.

The Kindleberger language analogy is apt: Iranian customs officials demanding payment in Mandarin would not make Mandarin the language of international commerce.

To dethrone the dollar as the pound was dethroned would require something on the scale of what happened between 1913 and 1950: two world wars, a global depression, widespread adoption of capital controls, and the physical destruction of Britain’s capacity to maintain its financial role. Nothing of that magnitude is currently visible.

What is visible, however, is a more gradual and less dramatic process that the existing literature has not fully theorized: the selective erosion of the institutional prerequisites that Eichengreen identifies, occurring not through catastrophic disruption but through the systematic weakening of the governance foundations on which reserve currency status ultimately rests.

Eichengreen’s five prerequisites map onto the current US situation with uncomfortable precision.

Quality assurance — the credibility of the dollar as a stable store of value — is threatened by a fiscal trajectory that the Congressional Budget Office projects will carry federal debt to 175 percent of GDP by 2056, combined with episodic pressure on the Federal Reserve’s inflation-fighting mandate.

Commercial prowess — the US role as the central node of global trade — is being actively undermined by a tariff regime that has accelerated partner diversification toward Chinese trade networks.

The sophistication of US financial infrastructure remains unmatched, but the weaponization of that infrastructure through sanctions has created powerful incentives for third parties to invest in alternatives.

Political checks and balances — Eichengreen’s most pointed concern are under the kind of stress that the historical record associates with the early stages of institutional deterioration. Geopolitical security — the ability of US military power to underwrite global order — is intact but at sharply rising fiscal cost.

None of these pressures is individually decisive. Collectively, and sustained over time, they constitute the erosion profile that has historically preceded reserve currency decline — not the dramatic collapse that “dollar doomerism” predicts, but the slow hollowing out that eventually made network effects insufficient to compensate for institutional decay.

V. The Wallis Framework and the Dollar

John Joseph Wallis’s institutional analysis, developed independently of the dollar debate, provides a useful structural frame for integrating the three perspectives. His central argument — that impersonal rules are the foundation of the coordination advantages that distinguish modern developed societies — applies directly to reserve currency status.

The dollar’s dominance rests not merely on network effects but on the credibility of the institutional framework that guarantees those effects will persist: that US courts will enforce contracts, that the Federal Reserve will not be subordinated to executive preference, that dollar assets will not be seized arbitrarily, that the rules governing dollar-clearing systems will apply equally to all participants regardless of their political relationship with Washington.

These are, in Wallis’s terms, external impersonal default rules — rules that participants can rely on as outside options without having to follow them in every specific transaction.

Their power comes not from active enforcement but from their predictability. The moment dollar infrastructure begins to be used selectively — to punish specific actors based on their political relationship with the US government rather than on any neutral legal principle — it begins to function as an identity rule rather than an impersonal rule, and its coordinative advantage is correspondingly reduced.

The weaponization of the dollar that Farrell and Newman document as a source of American power is, in Wallis’s framework, also a source of institutional vulnerability: every selective application of dollar infrastructure as a coercive tool reduces the confidence of third parties that their dollar assets are governed by predictable impersonal rules.

VI. The Synthesis

The three perspectives that opened this post are best understood not as competing but as complementary accounts of the same phenomenon at different time horizons and analytical levels.

Krugman is right about the near term: the dollar is not going anywhere soon, and the specific trigger of yuan-denominated Hormuz tolls is too small to matter structurally. The network effects of dollar dominance are deep and self-reinforcing, no credible successor exists, and the institutional catastrophe that would be required for rapid transition is not visible.

Eichengreen is right about the mechanism: the institutional prerequisites that underpin reserve currency status are being eroded, not by a single catastrophic event but by the gradual weakening of the governance foundations — rule of law, political checks and balances, institutional independence — that make impersonal rules credible. History shows that this erosion precedes displacement, sometimes with a very long lag.

Benigno provides the empirical bridge: the dollar’s safe-haven properties are conditional on the source of the shock, and a world in which the United States is increasingly the origin of economic uncertainty rather than the refuge from it is one in which the traditional reinforcing mechanisms of dollar dominance may function less reliably.

The Iran war strengthened the dollar. The tariff war weakened it. Both are ongoing, and their net effect on the dollar’s long-run institutional standing will depend on which dynamic proves more durable.

The dollar’s throne is not wobbling. But the bolts that secure it are being removed, slowly and not always visibly, by the very political choices of the country whose currency it is.

Krugman’s economics and Eichengreen’s history agree on the mechanism, if not the urgency: reserve currency status is ultimately a reflection of institutional quality, and institutional quality is ultimately a political choice.