The Bank Remembers
America built the world's financial order. Now the order is collecting.
The Trump administration has made a simple story the centrepiece of its economic worldview: America has been cheated. Foreign countries sell into American markets, accumulate dollars, and use those dollars to lend back to Washington at interest. Trade deficits, in this telling, are a measure of exploitation. The rest of the world gets factories, jobs, and growth. America gets debt.
It is a story with genuine emotional and political force. It is also, in important ways, backwards.
For decades, the US has occupied a position in the global economy that no other country has ever held for so long: issuer of the world’s reserve currency. That status, critics argue, allows Washington to consume more than it produces, borrow without limit, and export its deficits to everyone else. Far from being the victim of a rigged system, the US built the system, and has been its primary beneficiary. This is what Valéry Giscard d’Estaing, then France’s finance minister, meant in the 1960s when he coined the phrase “exorbitant privilege”.
The situation, however, is more complicated. The economists who have studied this most carefully — Paul Krugman, Hélène Rey, and others — reach a more qualified conclusion: the privilege exists, but its economic value is probably smaller than either its champions or its critics claim. In a recent post on X, Izabella Kaminska of The Blind Spot goes even further: the dollar system was never primarily designed to let America live beyond its means. It was designed to keep the West’s military and industrial capacity coordinated under American leadership.
So why is America now stating that it’s being taken advantage of? And why is the rest of the world under the impression that the US is abusing its exorbitant privilege? This, as can be expected, is a long story—and a sign that something has gone seriously wrong.
The Architecture of Dollar Dominance
To understand any of this, it helps to be clear about what reserve currency status actually means — and why it is so durable.
The dollar is not dominant because of a law or a treaty. There is no world government requiring Brazilian importers to pay for Malay goods in US currency. The dollar dominates for the same reason English dominates international commerce: because everyone else uses it. Paul Krugman, drawing on a 1967 paper by Charles Kindleberger, has argued that this analogy is more than illustrative. It captures the deep structural logic of currency dominance. Just as it invoices in dollars, a Brazilian firm negotiating with a Malaysian counterpart conducts the conversation in English, not because either party chose America, but because those are the languages — linguistic and monetary — that minimise friction when strangers trade.
Data shows that this self-reinforcing network effect is remarkably stable. As pointed out by Paul Krugman, the dollar is involved in 88 per cent of all foreign exchange transactions, dominates global trade invoicing outside Europe, accounts for nearly 60 per cent of central bank reserves, and underpins some $20 trillion in foreign-held dollar assets. The euro is a distant second. The yuan barely registers.
The roots of this dominance lie in events that happened at the end of World War II. The Bretton Woods conference of 1944 placed the dollar at the centre of a new international monetary order, backed by American gold reserves and the overwhelming productive capacity of an economy that had emerged from the war intact while Europe lay in ruins. When that gold-backed system collapsed in 1971, the dollar’s dominance survived through a different mechanism: the petrodollar agreement of 1974, under which Saudi Arabia and OPEC agreed to price oil exclusively in dollars in exchange for American security guarantees. Any nation that needed energy — which meant every nation — needed dollars. Those dollars were recycled into US Treasury bonds, creating a permanent captive demand for American debt.
That petrodollar recycling loop, however, is now fading. Izabella argued, presciently, as early as 2015 — when it was unfashionable to say so — that the petrodollar effectively died the moment America became energy-independent through shale. As for Brad Setser, he recently showed that petrodollars now play a marginal role in funding America’s national debt. In other words, the structural demand for dollars anchored to oil has been in decline for a decade. What has replaced it, at least in part, is what Izabella calls the “sweat dollar”: the dollars that flow outward to pay for imports from countries whose comparative advantage is cheap labor, most notably China. And beyond that, our theory at Currency of Power is that a new digital recycling loop is being engineered, anchored not in oil but in artificial intelligence infrastructure (GPU dollars) and dollar-backed stablecoins (cryptodollars).
The architecture changes. The dominance persists.
Exorbitant Privilege: Real, but Qualified
So does this dominance let America live at the world’s expense?
The intuitive case for “yes” runs as follows. To supply the world with dollar liquidity, the US must run persistent trade deficits — it must import more than it exports, pushing dollars outward while absorbing foreign goods. The world, in turn, recycles those dollars into US Treasuries, lending Washington the money to fund its deficits at low rates. America consumes; the world produces; and the bill is deferred indefinitely onto a growing stack of sovereign debt now approaching 122 per cent of GDP—even more when you account for private debt as well.
This is a phenomenon known as the Triffin dilemma: the very mechanism that makes the dollar indispensable to the world hollows out American manufacturing, as a persistently strong currency makes US exports uncompetitive. The US gets cheap imports, cheap borrowing, and a bloated financial sector. It loses factories, and the communities that depended on them.
Hélène Rey and Pierre-Olivier Gourinchas have documented what they call the “hedge fund nation” dimension of this privilege: the US issues low-yielding safe assets (Treasuries) and invests the proceeds in higher-yielding foreign equities and direct investments, earning a structural excess return of roughly 1.5 per cent per year in real terms. America, in other words, borrows cheap and invests dear — a carry trade run at national scale.
But Paul Krugman urges caution about overstating all this. He points out that the notion of a “unique” American ability to run sustained trade deficits is simply false: Australia ran massive current account deficits for three decades without holding reserve currency status; the UK has done the same since 2000. The ability to borrow from global markets is not exclusive to the dollar’s issuer. Paul also notes that Ben Bernanke, examining whether dollar status lowers US borrowing costs, found no clear evidence of the effect. The economic value of the privilege, Paul concludes, is probably not large relative to the size of the American economy.
Where the privilege is unambiguous, he argues, is in power rather than economics. Because so much of world trade and finance runs through the US banking system, Washington can observe and block transactions across borders. This is the weapon behind sanctions such as those imposed upon Russia and Iran — and it is a genuinely formidable one. When the US froze Russia out of dollar clearing after the invasion of Ukraine, it demonstrated that exclusion from the dollar system is close to exclusion from the global economy. Iran’s alleged demand that tolls through the Strait of Hormuz be paid in yuan or cryptocurrency is, in this light, less a sign of dollar weakness than a sign of how badly a sanctioned state wants out.
So the picture that emerges is this: the exorbitant privilege is real, but its economic dimension is modest and comes with a structural cost (deindustrialization). Its power dimension — the ability to weaponize dollar clearing — is large, and is not obviously a form of living beyond one’s means. It is more like owning the world’s only bridge and being able to decide who crosses.
The System Was Not Built for This
This is where we need to discuss Izabella’s argument that the dollar is not about allowing America to live beyond its means.
