What role will the dollar and US government bonds play in the future?

In light of concerns about the development of government debt, yields on US government bonds have risen recently. In turn, the prices of fixed-income securities have fallen. The higher yields signal that investors see greater risk in investing in US government bonds and are demanding a higher risk premium in return. In addition, political uncertainty and rising debt are also weighing on confidence in the US dollar. Chief Investment Officer Gerold Permoser answers the most important questions about the future of the dollar and US government bonds, which are so important for the financial market.

What exactly is “money” and why is the US dollar important in this context?

Economists generally define money in terms of four functions:

1. Money is a medium of exchange—everyone accepts it as a means of payment.
2. Money is the unit of account – prices are quoted in the respective monetary units;
3. Money is a store of value – purchasing power can be shifted over time.
4. Money is a safe haven – in times of crisis, money can be “traded” at face value.

Within a country, the national currency normally fulfills all four functions. Across borders, this role is usually played by the US dollar. Whenever a shipment of copper is invoiced, a bank derivative is margined, or a fund manager hoards “dry powder” for a downturn, there is a high probability that it will be done in dollars. In short, the dollar is global money because it simultaneously facilitates trade, records value, stores wealth, and is the world’s preferred safe-haven asset.

There are also practical considerations. Economists talk about so-called network effects. If all market participants use the US dollar, an infrastructure will develop around the USD (e.g., a well-developed legal framework, a large number of service providers, risk transfer instruments, efficient derivatives markets, etc.). This infrastructure in turn makes it more likely that market participants will use the USD. This network effect can mean that, once a certain size is reached, it no longer makes sense to consider alternatives.

Why are US government bonds so important for the global financial system?

US government bonds are the foundation on which all other financial markets stand. They are the deepest and most liquid market for safe assets. Whenever someone uses US dollars, they can quickly and easily “park” them in US government bonds. Added to this are a number of applications that essentially result from network effects: they stabilize the repo markets (which in turn allow short-term loans to be obtained), cover margin calls at clearing houses (which reduces the risk for all participants in the derivatives market), and provide the reference curve for “risk-free” returns, which are used to value everything from mortgages to emerging market bonds (meaning that US government bonds are implicitly embedded in all other financial instruments). And that is only part of the applications of US government bonds.

The dollar is considered the global reserve or key currency. What does that mean?

This means that central banks hold it as the dominant share (≈ 58%) of all disclosed foreign exchange reserves, that companies settle most cross-border contracts in dollars, and that global banks are predominantly financed in dollars and deposit collateral in dollars.

This in turn leads to steady demand for US dollars and also for US government bonds (in order to “park” the dollars). And as always when something is in high demand, this has an impact on the price or, in the case of bonds, on the interest rate at which the issuer, i.e. the US government, can borrow. In other words, the US can borrow more cheaply because the dollar is the reserve currency.

What is the relationship between foreign trade and reserve holdings?

Since a large proportion of international trade is conducted in dollars, companies need to obtain the necessary dollars. Put simply, this is done by selling goods and services to US citizens, who then pay for them in US dollars. The dollars that have migrated abroad in this way must then be parked, which is where the market for US government bonds comes into play. Against this backdrop, it is understandable why the current Trump administration is linking US government bonds held by foreigners to the trade deficit – services are incorrectly omitted here.

What other advantages does the dollar’s status as a reserve currency offer?

This not only gives the US the advantage of cheaper loans, but also allows it to borrow heavily abroad without risk. Given the high demand for the reserve currency, there is no fear that foreign investors will suddenly stop investing, causing yields to rise or the currency to depreciate. The US is in a much better position here than other markets with the same fundamental indicators (e.g., level of government debt, foreign debt).

Another advantage is the high demand for US dollar cash. Economist Kenneth Rogoff, for example, estimates that approximately US$1 trillion is held in cash outside the US. This sum is effectively an interest-free loan to the US. At an interest rate of 4%, this would correspond to a benefit of $40 billion for US taxpayers.

The US is, of course, also benefiting from the additional demand for its financial system. The world’s largest financial market is becoming even bigger, more liquid, and more efficient as a result of the activities of foreign players. This can be seen in many areas, such as very deep and diverse hedging markets and the associated ability to transfer risks effectively and cheaply to market participants who are willing to hold them. This, in turn, has given rise to a financial industry that is a significant economic factor in the US. This can also be seen in the foreign trade figures. While the Trump administration always focuses on trade in goods, where the US has a deficit, there is also trade in services (such as financial services), where the US has a massive surplus.

Another advantage for the US is the geopolitical influence it wields through sanctions and access to dollar clearing. Whereas sanctions used to be imposed primarily on trade flows, they have now shifted to financial flows. This is a clear consequence of the fact that the US has lost importance as a trading partner but, as the provider of the reserve currency, the US dollar, is still number one in financial services.

And the disadvantages?

In the US, there has been much discussion recently about the disadvantages of the US dollar as a reserve currency and the associated demand for US government bonds. On the one hand, the so-called Triffin dilemma was raised. Economist Robert Triffin warned that the issuer of the reserve currency would ultimately be faced with a choice between supplying the global economy with global liquidity on the one hand and managing government debt sustainably on the other. According to this interpretation, the enormous government deficits in the US are not due to the fact that the US consumes more than it produces, but rather that foreign countries are effectively forcing Americans to take on more and more debt because they want to get their hands on the dollars and bonds associated with it. Ultimately, both sides – the foreign trade deficit and its financing – go hand in hand. The question is always which side provides the impetus. This has been one of the central issues in economics over the last 20 years.

Outside the US, there is one issue in particular that was summed up by former US Secretary of the Treasury John Connally to European finance ministers in 1971: “The dollar is our currency, but your problem.” US monetary policy is geared to the needs of the US economy and not to the needs of its role as a global reserve currency. If US key interest rates rise, e.g. because the US economy is overheating, the US Federal Reserve does not consider whether other economies currently need lower interest rates in US dollars or easier access to financing, but raises interest rates anyway.

What challenges is the US government bond market currently facing?

There are currently a number of issues being discussed in relation to the US government bond market:

• A seemingly unstoppable rise in the supply of US Treasuries. Behind this lies the enormous US budget deficit, which of course has to be financed. The Congressional Budget Office, a US agency tasked with assessing the future development of the US budget, forecasts that government debt will reach 156% of GDP by 2055. And this does not even take into account the Trump administration’s planned tax cuts.
• High refinancing requirements in the coming months and years. Around one-third of all marketable government bonds will mature in the next three years. This means that enormous volumes will have to be refinanced at coupons that are around 200 to 300 basis points above those of current bonds. With an outstanding volume of around US$28 trillion, this would lead to additional interest expenses of around US$200 to 300 billion. Of course, buyers will also have to be found for this enormous sum.
• A change in the maturity structure of outstanding government debt. In their white paper Activist Treasury Issuance and the Tug-of-War Over Monetary Policy, published in July 2024, Stephen Miran and Nouriel Roubini claimed that the US Treasury under Joe Biden had been running a “stealth QE” program. By issuing more short-term Treasury bills instead of longer-term government bonds, the yield on government bonds was pushed down. For 10-year yields, the effect was equivalent to about 25 basis points, which the authors say is equivalent to a stimulus equivalent to a one percentage point cut in the key interest rate. If the maturity structure of debt securities “normalizes” again, yields could rise by 30 to 50 basis points, they warn.
• Since the beginning of the Trump presidency, the decisions of the US government have also had a noticeable impact on the market for US government bonds and the USD. There are several channels through which this impact is felt. One of these is the Stability is the core business of a currency. Rapidly changing decisions with potentially far-reaching consequences, such as the tariffs proposed by Donald Trump, naturally weigh on a currency and the market for government bonds denominated in that currency.
• All of this has manifested itself in increased rating pressure. On May 16, 2025, Moody’s downgraded the US credit rating to Aa1, citing the country’s $36 trillion debt burden and rising interest costs. This means that the US, still widely regarded as the epitome of security, no longer has the highest rating from any of the major rating agencies.

Is a Trump-induced debt haircut looming?

In the US, a genuine default is extremely unlikely to impossible. The US Federal Reserve can always step in and buy US bonds to finance them. This may require a new or amended framework for the central bank, but this can be created. In such a situation, however, a devaluation of the US dollar would be expected. The risk would therefore be devaluation rather than default. However, this scenario is not currently under discussion.

Nevertheless, there is currently repeated discussion about a US default. This discussion has two origins.

• On the one hand, there are considerations from the Trump camp that aim to persuade foreign investors to buy or hold US government bonds on terms that are more favorable to the US. Since this would obviously not be in the interests of these investors, this result could not be achieved on a voluntary basis. Depending on the type of coercion used (e.g., discounts on tariffs, military security guarantees, or forced conversion into perpetual bonds), this could be legally considered a default. However, it must also be clearly stated here that Steve Miran (Trump’s chief economic advisor), who is considered the mastermind behind these ideas, a) has already backtracked and b) clearly pointed out in a paper that this scenario should be avoided at all costs due to its adverse effects on the US.
• On the other hand, discussions surrounding an increase in the debt ceiling repeatedly raise the possibility of a US default. Here too, the likelihood of an actual default is low. A default would not be in the US’s interests and would probably be averted by a bipartisan majority in Congress.

Who actually wants to change the leading role of the dollar?

First and foremost, geopolitical rivals and commodity exporters—China, Russia, and the expanded BRICS bloc—as they are vulnerable to US sanctions due to their dependence on the dollar. In recent communiqués, the BRICS countries have pledged to expand “settlement in national currencies” and to explore a “common unit of account.”

China, in particular, has made great efforts to create an alternative to the US dollar. This was triggered by the global financial crisis of 2008, during which China realized how dependent world trade is on the availability of the dollar and the US financial industry. Accordingly, it wanted to build an alternative, the so-called CNH market. Technically, this has been achieved. In practice, however, this alternative only plays a role in a few trade relationships. As long as China does not offer a freely convertible currency and high-quality investment opportunities, demand for this alternative will remain low.

How does the issue of “security” relate to the “reserve status” of the USD?

There are two connections between the topics.

• As a global superpower, the US has provided two public goods to the world in the past. One is security, the other is the global reserve currency. Some representatives of the current US administration believe it is unfair that the US has to pay for these goods and are therefore calling for a change in the status quo (be it higher defense spending by NATO countries or a willingness to pay tariffs or a fee for the use of US Treasuries).
• On the other hand, the US repeatedly imposes financial sanctions when it wants to persuade other countries to follow US interests. Prime examples of this are the freezing of the Russian central bank’s USD currency reserves.

Are there any credible alternatives to the dollar?

No, there is currently no alternative to the US dollar in the sense that it could replace the USD as the global reserve currency in the short to medium term.

• Euro and yen: Although these currencies are backed by large financial markets, the euro lacks uniform fiscal support, and the liquidity of the yen is distorted by the management of the yield curve. Furthermore, both markets are significantly smaller than the US market.
• Renminbi: Although China is managing to persuade more and more countries to conduct their trade with China in CNY, capital controls mean that its use as a reserve currency (~4% of global reserves) remains severely restricted.
• Precious metals: Gold in particular has been a useful diversifier in portfolios in recent months and has also been in high demand from central banks. However, without the ecosystem of yield curves, repo transactions, and derivatives that government bonds offer, its use as a global reserve standard is also limited.

At present, it seems highly unlikely that the US dollar will not continue to be the global reserve currency in five years’ time. However, it seems equally likely that many players will attempt to free themselves from the US dollar, at least to a small extent.

What would be the consequences if the world turned away from the dollar?

• The losers would be the US and US taxpayers, as the US would have to pay higher borrowing costs. In practical terms, this would mean higher yields on US government bonds compared with the current status quo.
• It would also be reasonable to assume that the US dollar, which is already expensive, would come under additional pressure as a result of losing its reserve currency status. Accordingly, a weaker US dollar would be expected. One beneficiary of this development would probably be the euro, which should gain in value against the US dollar.
• Another loser would probably be the US financial industry, which currently benefits from the fact that US assets are in demand around the world and are largely managed through the US ecosystem.

But let me make this clear once again. It is highly unlikely that the USD will lose its reserve status in the next five years. Investors are in the process of finding and utilizing alternatives. However, the US has the deepest and broadest financial market in the world, it has the infrastructure to leverage this market and the resulting network effects that have left all other markets behind. Only the US itself can change this status in the short term. And that is not in its interest.

 

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