Power of the Dollar, US Deficits and Crypto

That status has also provided political cover for certain US administrations to pursue aggressive tariff policies. At the heart of the discussion lies America’s so-called "twin deficits": a persistent goods trade deficit and a large budget shortfall. The central question is whether the US can sustain the dollar’s reserve currency role without running these deficits.

In recent weeks, prominent economists including Gita Gopinath, Michael Pettis and Brad Setser have engaged in a sharp debate over the dollar’s impact on global imbalances.

The discussion and causality

Gita Gopinath, professor of economics at Harvard and former IMF chief economist, argued in the Financial Times that the deterioration in the US net international investment position (NIIP) is not primarily the result of chronic trade or current account deficits. Instead, she points to the superior returns of US equities relative to other markets, amplified by the dollar’s strength.

Foreigners, she notes, continue to earn more income from their US investments than Americans earn abroad. Because much of this exposure is in equities, any significant pullback in US markets would likely manifest as a stock market correction rather than a sovereign debt or rollover crisis. Gopinath also highlights that countries running large trade deficits with the US, such as China, are not necessarily accumulating large volumes of US assets.

She suggests that reducing the US budget deficit – currently running at around 5.7% of GDP – alongside China shifting toward a more consumption-driven growth model would be the most effective way to narrow the trade imbalance.

Pan Gongsheng, governor of the People’s Bank of China, offered a different perspective in a recent speech. He noted that in a system dominated by a single reserve currency, the issuer can sustain large fiscal deficits and current account deficits at relatively low borrowing costs, effectively exporting its currency to the rest of the world. These capital inflows, he argued, tend to overvalue the reserve currency and erode the issuer’s manufacturing competitiveness.

Michael Pettis, a senior fellow at the Carnegie Endowment, broadly agreed, adding that the US role as the "absorber of last resort" for excess global savings leads to lower domestic saving rates and higher American debt rather than increased productive investment.

Gopinath pushed back, arguing that empirical evidence does not support a strong link between reserve currency status and persistent current account deficits. She pointed to historical examples such as the UK, which ran current account surpluses during its period as the dominant reserve currency issuer, and Switzerland, which often runs surpluses while the Swiss franc remains a major safe-haven currency.

Counterarguments and assumptions

A counterargument to Gopinath’s view is that countries prefer to hold dollars as the reserve currency. Running a trade surplus with the US (while the US runs deficits) helps them achieve that. As global trade grows, so does the need to hold US dollars – and with it, the US current account deficit.

Brad Setser, former director of the US National Economic Council, notes that foreign dollar reserves contributed to the rise in the US current account deficit both before and after the global financial crisis of 2008. However, he points out that the recent surge in the deficit has not been driven by an increase in foreign dollar holdings, as reserve growth has been relatively muted. This suggests that the additional debt is largely being absorbed domestically. Setser agrees that running an external deficit is not necessarily a prerequisite for issuing a global reserve currency.

Pettis later emphasized the importance of underlying assumptions in these discussions. He argues that what matters most is which assets foreigners choose to acquire with the income from their trade surpluses. If surplus countries deploy their excess savings into capital-rich economies such as the US, UK and Canada, those countries will tend to run deficits.

Economic textbooks suggest that excess capital inflows should spur growth in developing countries, provided the money is invested in productive sectors. Pettis contends, however, that when additional capital flows into advanced economies where domestic investment is already constrained by sluggish demand, it does not lead to higher investment. Instead, it results in reduced domestic saving or higher debt levels — as seen in the US. In such cases, capital inflows tend to boost asset prices, lower borrowing costs and strengthen the currency.

Current account surpluses from foreign countries must ultimately be balanced by the acquisition of assets, many of which are based in the US. According to Pettis, unless the US intervenes, this dynamic leads to the US running a deficit with those surplus countries. He draws a parallel with China, noting that simply reducing the US fiscal deficit will not necessarily shrink China’s surpluses, as those are largely a function of Chinese domestic policies. In fact, cutting the US deficit could even result in larger capital inflows if the US continues to be perceived as a safe asset haven.

Implications for cryptocurrencies

From a macroeconomic standpoint, the debate over US deficits and the dollar has only tangential relevance to cryptocurrencies. The causality between deficits, capital flows and crypto pricing is weak. However, the dollar’s continued dominance in global invoicing and settlements is likely to be supported – and potentially strengthened – by the growth of dollar-backed stablecoins.

The impact on the reserve currency aspect (the store-of-value function for foreign official savings) is expected to remain limited, largely because current regulations, including the GENIUS Act, prohibit the payment of interest on stablecoins.