The world’s emerging economies are mounting a challenge to American hegemony and have taken aim at one of its most powerful assets, its currency. While the US dollar has been in a slow-motion decline for some decades, it is facing a renewed threat from an insurgent China and a revanchist Russia, who are working to remake the geopolitical landscape in the wake of the wars in Ukraine and the Middle East. 

Although the dollar still maintains a commanding lead over its chief competitors as a reserve currency, its power continues to wane. To shore up the US economy the Federal Reserve is pumping money into the system – a strategy many analysts view as unsustainable. CEO and founder of the deVere Group, Nigel Green, warned on Tuesday (April 30) that failing a course correction, there was a scenario in which the dollar could go the same way as the crisis-hit Japanese Yen. 

The Fed left interest rates unchanged when it met in May. Speaking ahead of the move, Mr Green said: 

“The Yen is collapsing because Japan has massive debt, 260 per cent of its GDP. America’s debt is well over 100 per cent. 

“Japan needs to raise interest rates, but if it raises interest rates, it causes its own borrowing to become more expensive, and it can’t afford to repay its debts. 

It is attempting to defend its currency, spending as much as $40 billion in one day. Historically, that hasn’t worked; it’s temporary. Ultimately, borrowing is the problem, and America is heading the same way. 

While the dollar isn’t there yet, it will be in the future if they keep borrowing money. Countries can’t just keep borrowing money; if they do, they will have issues.” 

Is the US dollar in a ‘death spiral’? 

The warning comes as one eminent analyst claimed the US currency was suffering a ‘death spiral’ as a result of the country continuing to raise its debt ceiling – that is, the amount of money the US government is authorised to borrow. Former trader and statistician Nassim Nicholas Taleb said:

“[A]s long as you have Congress keep extending the debt limit and doing deals because they’re afraid of the consequences of doing the right thing, that’s the political structure of the political system, eventually, you’re going to have a debt spiral,”

 While most analysts agree that the collapse of the American currency isn’t coming any time soon, they agree that high inflation and high debt pose real risks. Writing for Investopedia, Sean Ross warned that spiralling interest rates could cause foreign creditors to collapse the currency. He said:

“There are some conceivable scenarios that might cause a sudden crisis for the dollar. The most realistic is the dual threat of high inflation and high debt, a scenario in which rising consumer prices force the Fed to sharply raise interest rates.”
“Much of the national debt comprises of relatively short-term instruments, so a rate spike would act like an adjustable-rate mortgage after the teaser period ends. If the U.S. government struggled to afford its interest payments, foreign creditors could dump the dollar and trigger a collapse.”

While the dollar is not facing an imminent threat of collapse, long-term weaknesses result in some investors looking at hedging against the dollar, including through investments in mutual funds, EFTs and gold. The deVere Group CEO Nigel Green highlighted gold as one possible alternative:

“Right now, we are watching and realising countries can’t just keep borrowing money. Gold is an alternative; it continues to go up—and is 165 per cent up over the last 12 months against the Yen. It goes to show that it is always good to diversify, and potentially, gold is a good alternative.”

Tesla boss warns national debt could collapse the dollar

The CEO of Tesla and SpaceX, Elon Musk, warned this month that the dollar’s value would collapse unless the country’s spiralling debt is controlled. Taking to the X platform, formerly known as Twitter, Musk said: 

“We need to do something about our national debt, or the dollar will be worth nothing.”

And added:

“Just stating the obvious.”

The remarks follow a similar intervention by the tech CEO in 2023 when he accused “heavy-handed” US foreign policy of tempting other nations to dump the dollar.

Responding to Grit Capital founder Genevieve Roch-Decter, who argued the dollar’s reserve status was imperilled, Musk said:

“This is a serious issue. US policy has been too heavy-handed, making countries want to ditch the dollar. Combined with excess government spending, this forces other countries to absorb a significant part of our inflation.”

 It comes weeks after Deputy IMF chief Gita Gopinath criticised the USA’s budget deficit as being too high. In an April interview with Bloomberg, she said:

“The U.S. is running [a] very large deficit for a country with strong demand, and they still have to deal with the last mile to bring inflation down.
“We can’t have a deficit of 7% of GDP; it needs to be lower.”

Will high interest rates help or hinder the dollar?

Just weeks ago, analysts had expected several interest rate cuts in 2024. However, after fresh inflation fears were sparked by higher-than-expected price rises, a rate cut now looks unlikely this year. While that means some investors may keep hold of the dollar, it also puts pressure on the cost of the US government servicing its debt, potentially creating the conditions for bigger problems down the road.  

Interest rates are likely to see little downward revision until the Fed feels it is making progress toward depressing inflation toward its goal of 2 per cent. Investors had expected as recently as April that interest rates would fall by 1.5 percent this year, but those forecasts have now reportedly fallen to an average of just half a point, according to The Economist. 

A recent report by the Financial Times said a bullish dollar could result in countries selling off the currency as it disrupts trade flows and exports inflationary pressure. Although they added any sell-off of the dollar by the US itself remained unlikely:

“A bullish dollar could also add to existing stresses in the financial system, particularly by raising debt repayments facing emerging economies. IMF managing director Kristalina Georgieva has warned that high US rates could cause a slew of defaults — with the potential for regional or global spillover.“Potential solutions are few and far between. Many countries sit on large reserves and could sell off dollars. But if interest rates in the US continue to stray from the pack, any intervention would be momentary and come at the cost of liquidity. While the US could theoretically undertake a coordinated dollar-selling effort, most analysts view this as unlikely.”

However, most observers predict the dollar’s strong position to hold out in the near term, according to one recent Reuters poll of 66 analysts. Reporting on the findings, the outlet noted: “Shrugging off a weakening trend late last year, the dollar has gained against nearly every currency tracked by traders and investors.”

Is the US dollar still a safe haven? 

While the dollar faces mounting challenges from emerging economies and geopolitical shifts, it remains dominant as the world’s reserve currency. However, this position is not without vulnerabilities, particularly in the face of mounting US debt.

While analysts urge caution about the USA’s more than $16 trillion in debt obligations, the dollar’s collapse is not imminent. However, the long-term weaknesses of high inflation and rising debt levels should be a warning sign for investors.

The Federal Reserve’s efforts to prop up the economy through monetary stimulus raise concerns about the sustainability of the dollar’s strength. Persistently high interest rates could stifle growth and increase the burden of servicing US debt.

Investors may choose to diversify their portfolios to hedge against the risks associated with the dollar. Gold, mutual funds, and ETFs may present alternatives for those seeking to protect their assets from currency devaluation and economic instability. While the near-term outlook for the dollar remains strong, with analysts predicting its continued resilience, the potential for unforeseen events to trigger a crisis cannot be ignored. As such, it is often said to be prudent to maintain a diverse portfolio.