The U.S. Dollar in the Era of Trade Fragmentation

📊 The U.S. Dollar in the Era of Trade Fragmentation: Structural Challenges and Geopolitical Pressures

Introduction

The U.S. dollar remains a cornerstone of the global financial system. However, current developments—from trade wars to pressures on the Federal Reserve and the rise of geoeconomic selectivity—are beginning to alter not only the conditions under which it operates but also the very nature of global currency leadership. This article examines the real and potential threats to the dollar’s stability in the current environment and assesses the fundamental nature of these shifts.​

1. U.S. Trade Policy and Its Impact on the Dollar

Since the onset of trade wars in 2018, the U.S. has consistently pursued a course toward economic sovereignty. This is manifested through:​

• Imposing tariffs on imports from China, the EU, and other countries.​

• Strategies for localizing supply chains (reshoring, friendshoring).​

• Stimulating domestic industrial production, especially in sectors related to critical technologies (microelectronics, batteries, defense products).​

📉 Short-Term Consequences

The implemented barriers typically lead to increased production costs:​

• Higher costs for imported components and raw materials.​

• Disruption of economies of scale.​

• Pressure on margins and final consumer prices.​

Simultaneously, overall total factor productivity (TFP) declines, as localized supply chains are less efficient compared to optimized global logistics structures. All this creates conditions for stagflationary pressure, especially in industries with high import dependence.​

🔄 Response from Trade Partners

The U.S.’s protectionist policy has not gone unanswered:​

• China has refrained from new stimulus measures to avoid weakening the yuan and maintain macroeconomic stability.​

• The EU, Japan, and Canada are strengthening bilateral and regional agreements, bypassing the U.S. (e.g., the EU-MERCOSUR agreement).​

• Beijing has openly warned of “strong retaliatory actions” if Washington attempts to isolate China through third countries.​

These steps are leading to a restructuring of global trade routes and currency flows, gradually reducing the dollar’s share in regional settlements.​

💵 Impact on the Dollar

• Short-Term: The dollar may receive support as a “safe haven” amid global uncertainty, as observed during periods of heightened rhetoric between the U.S. and China. This explains the strength of the DXY in 2022–2024.​

• Medium-Term: Isolationism limits the U.S.’s ability to influence global value chains. Capital flows that previously sought dollar infrastructure are beginning to partially orient toward local alternatives, including currencies of allied countries and regional trade blocs.​

• Long-Term: The systematic weakening of the U.S.’s role as a coordinator of global trade leads to erosion of the trust architecture that historically underpinned dollar hegemony. This is expressed in:​

  • The gradual decline in the dollar’s share of international reserves.​

  • Growing interest in gold, commodity assets, and multi-currency baskets.​

  • An increase in trade operations outside the dollar (e.g., yuan settlements between China and Asian countries, euro within the EU and with North Africa).

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2. U.S. Monetary Policy: Pressure on the Federal Reserve and Its Consequences

In 2025, a key factor of instability in U.S. monetary policy is the increasing pressure from President Donald Trump’s administration on the Federal Reserve. Direct public statements by the president, criticizing Fed Chair Jerome Powell and demanding rate cuts despite persistent inflation, undermine the perception of the Fed as an independent institution.​

🏛 Disruption of Institutional Balance

The politicization of monetary policy carries several systemic risks:​

• Erosion of confidence in the Fed’s independence: Open interference from the White House creates expectations that rate decisions may be influenced by political considerations rather than macroeconomic assessments.​

• Instability of forward guidance: The effectiveness of Fed communications diminishes—investors pay more attention to the president’s statements than to those of the regulator.​

• Undermining long-term policy predictability: Economic agents lose the ability to form stable expectations regarding inflation, rates, and market conditions.​

Particularly significant is the discussion of potentially removing the Fed Chair, a highly sensitive issue for markets, as it calls into question the very principle of separation of powers in economic governance.​

📉 Consequences for the Dollar and Dollar-Denominated Assets

The undermining of the Fed’s independence directly affects the perception of the dollar as a currency based on institutional stability:​

• Increased political risk premium in dollar instruments, especially at the long end of the yield curve.​

• Reduced demand from international investors, particularly central banks managing currency reserves.​

• Erosion of the dollar’s status as a safe-haven asset—especially amid heightened geopolitical and fiscal risks in the U.S.​

🔍 Structural Challenges

• Decreased effectiveness of interest rate policy: If the rate is perceived as a result of pressure, its signaling function weakens, leading to distorted monetary policy transmission.​

• Growth of institutional arbitrage: States and international investors increasingly evaluate alternative jurisdictions with more predictable macroeconomics—primarily Switzerland, Norway, and Canada.​

🧾 Conclusions for the Section

In 2025, the Fed faces not only economic challenges but also the problem of maintaining institutional legitimacy. Political pressure from the Trump administration reduces its independence, negatively impacting the long-term sustainability of the dollar as a global currency standard.​

As a result:

• Volatility of the dollar yield curve increases.​

• Risks of capital

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3. Capital Flows and the Changing Structure of Global Investment

For decades, the U.S. dollar maintained a privileged position in the international system thanks to a combination of three core factors:

• Predictable U.S. macroeconomic policy,

• Deep and liquid financial infrastructure,

• Institutional stability and legal protection of capital.

These pillars secured the dollar’s informal status as the default bearer of global trust. However, by 2025, clear signs have emerged indicating a structural transformation in global capital allocation—both from public and private actors.

📉 Declining Share of the Dollar: Trends and Drivers

According to IMF data, the dollar’s share of official global currency reserves fell from 71% in 1999 to 57.8% in 2024. This decline is driven by several overlapping dynamics:

1. Technical Diversification
   Central banks are actively reallocating reserves among multiple currencies—euro, Swiss franc, yen, Singapore dollar, Chinese yuan (to a lesser extent), as well as gold and SDRs.

2. Emergence of Alternative Financial Hubs
   Institutional investors increasingly view London, Frankfurt, Zurich, Toronto, and Singapore as viable alternatives for capital allocation—particularly in light of growing political uncertainty in the U.S.

3. Declining Political Neutrality of the Dollar
   The use of the dollar as a geopolitical tool in sanctions regimes (Iran, Russia, Venezuela) has demonstrated that access to the dollar system can be restricted unilaterally. This is prompting countries to develop their own clearing mechanisms and backup reserve systems.

4. Incentives for Technological Diversification
   The development of central bank digital currencies (CBDCs)—notably by China—and the rise of independent infrastructures (Ripple, SWIFT GPI, CIPS) create opportunities for a partial decentralization of reserve functions.

🔁 Private Capital Behavior

The structural transformation is affecting not only state reserves but also the allocation patterns of cross-border private investment:

• Venture funds and hedge funds increasingly seek exposure to uncorrelated FX markets and commodity assets in politically neutral jurisdictions.

• Multi-currency structured products are becoming standard offerings on private banking platforms in Asia and the Middle East.

• The share of dollar-denominated transactions in global trade (per SWIFT data) is also declining: in 2024, less than 40% of all interbank transactions were settled in dollars—compared to 44% in 2018.

🧱 New Demand: Currency Platforms, Not Just Currencies

The key shift lies in the transition from “currency preference” to “infrastructure trust”:

Countries and investors no longer merely choose a currency—they choose a jurisdiction that guarantees access, capital protection, enforceability of transactions, and legal recourse.

As such, the focus is increasingly on platforms that are:

• Technologically neutral (multi-account payment interfaces),

• Politically non-aligned (less exposed to sanctions risk),

• Institutionally transparent (regulatory clarity, legal safeguards, and market depth).

🧾 Section Summary

While the dollar still dominates the global system, the structural fragmentation of global capital is now a reality—and it is accelerating under pressure from:

• Geopolitical risk,

• Institutional fragility in the U.S.,

• Growth of “trust jurisdictions” and digital liquidity infrastructures.

This does not signal the collapse of the dollar system, but it does imply:

• Stricter quality requirements for dollar-denominated assets,

• Erosion of the dollar’s automatic appeal in new portfolio strategies,

• Increased importance of FX hedging and multi-currency allocation as a new global norm.

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4. China, the Yuan, and the Currency Alternative: Realistic Prospects

Despite official statements by China and BRICS members regarding the need to create an alternative to the dollar, fundamental limitations remain:

• The yuan is not fully convertible,

• Capital controls are strict,

• Reputational predictability is limited,

• High net-worth individuals and capital continue to leave the country—with China leading global outflows in 2024.

As a result, neither the yuan nor a hypothetical BRICS currency currently possesses the institutional foundation required for global reserve status.

Efforts to create a reserve currency without open markets, independent legal institutions, and transparent governance remain structurally constrained. In this context, the dollar retains its status not because it is ideal, but because no viable alternative yet matches its institutional depth and global interoperability.

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5. Institutional Risks: Political Fragmentation and Trust in the Dollar

The appeal of the U.S. dollar as the world’s reserve currency has historically rested not only on economic fundamentals but also on the perception of the United States as a stable institutional core of the global order. This included:

• Durable political institutions,

• A robust legal system,

• Diplomatic leadership in multilateral frameworks (e.g., the UN, WTO, NATO),

• The ability to act as a neutral arbiter in international conflicts and transactions.

That perception is now under revision.

⚖️ Erosion of U.S. Soft Power: Implications for Currency Status

The proposed reform of the U.S. State Department—which includes the closure of embassies, elimination of human rights and democracy offices, and withdrawal from multilateral organizations—sends a strong signal to global markets: the U.S. is retreating from its traditional role as guardian of the international order.

This shift increases perceptions of political fragmentation and has several implications:

• Reduced trust among emerging markets in the dollar as a neutral settlement medium,

• Growth of localized trade agreements outside U.S. jurisdiction,

• Strengthening of diplomatic influence by alternative power centers—primarily China and regional blocs (ASEAN, African Union, BRICS).

🧩 Domestic Institutional Pressure

Beyond diplomacy, internal imbalances are undermining the predictability of U.S. governance:

• Inflation remains above the Fed’s target, despite monetary tightening in 2022–2023, undermining confidence in policy effectiveness.

• Fiscal space is constrained: U.S. debt exceeds 120% of GDP, and ongoing debates over stimulus packages raise questions about long-term fiscal sustainability.

• Political polarization in Congress impedes timely economic decisions—such as government funding extensions, budget approvals, and debt ceiling negotiations. This increases the frequency of technical default risks and threatens the perception of U.S. Treasuries as truly “risk-free” assets.

• Escalating U.S. sanctions regimes (on Iran, Russia, China, and partially Turkey) are perceived as geopolitical instruments, eroding the dollar’s universality and increasing the incentive for non-dollar alternatives.

🧮 Bottom Line: Institutional Asymmetry

The U.S. retains technological and market dominance, but its institutional universality is weakening. This creates an asymmetry:

• The dollar remains liquid and structurally convenient,

• But is increasingly seen as a national, not global-neutral, asset.

While this does not imply an imminent abandonment of the dollar, it leads to:

• A higher risk premium on U.S. sovereign debt,

• Greater appetite for reserve diversification among central banks,

• Rising demand for “neutral” alternatives—such as gold, commodities, certain national currencies (CHF, SGD, CAD), and emerging digital liquidity protocols.

📌 Section Takeaway

The institutional resilience of the United States has long been the backbone of dollar dominance. As that resilience weakens, the following risks are magnified:

• Currency politicization,

• Erosion of confidence in regulatory systems,

• Increased volatility in long-dated dollar-denominated assets.

In an increasingly fragmented global order, the dollar is no longer perceived as a neutral asset with global oversight, but as a sovereign asset with global consequences.

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6. Investment Implications and Strategic Takeaways

The shifting foundations of dollar dominance—from macroeconomic management to institutional neutrality—are creating a new reality for global investors. The dollar, once predictable in times of crisis and recovery, is now increasingly exposed to political, legal, and fiscal shocks.

⚠️ Structural Risk Breakdown by Time Horizon

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📉 Key Risks to Dollar-Denominated Assets

• Loss of the dollar’s status as a politically neutral currency, especially in South-South trade relationships.

• Increased market volatility, driven by fragmented communication between the Fed and the executive branch.

• Elevated institutional risk premium on U.S. assets—from Treasuries to USD exposure in ETFs and mutual funds.

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💪 Persistent Supporting Factors

• Unmatched depth and liquidity in dollar markets—especially during global liquidity crises.

• Alternative currencies—yuan, euro, digital assets—still lack the legal and institutional protections offered by the U.S. system.

• The U.S. legal framework continues to uphold strong property rights and enforceability, especially for non-resident investors.

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🛠 Practical Investment Recommendations

🔹 Tactical Positioning (6–12 months):

• Reduce exposure to long-duration U.S. Treasuries; favor short-term, highly liquid instruments (e.g., T-Bills, floating rate notes).

• Use real assets as inflation and uncertainty hedges—gold, copper, uranium, agriculture.

• Avoid high-risk dollar assets in jurisdictions vulnerable to U.S. sanctions.

🔹 Strategic Allocation (12–36 months):

• Multi-currency diversification: Build allocations in institutionally trusted secondary currencies (CHF, SGD, CAD, NOK).

• Utilize basket-currency instruments and FX overlay strategies at the portfolio level.

• Integrate digital instruments (tokenized bonds, stablecoins, CBDCs) issued in jurisdictions offering legal enforceability and regulatory clarity.

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📌 Final Strategic Takeaway

Even amid institutional erosion, the dollar remains a core asset in global portfolios. But its role has shifted—from an automatic anchor to a conditional component requiring selective use.

The key skill for investors in 2025 is not simply choosing between risk and yield—it is managing institutional and jurisdictional risk within currency exposure.

This means:

• Continual reassessment of FX allocations,

• Clear understanding of jurisdictional vulnerabilities,

• A shift from “what currency to hold” toward “what system to trust”.

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Conclusion

The U.S. dollar continues to serve as the backbone of the global financial system—for trade, reserves, and pricing. But its status is no longer unconditional. It increasingly depends not on the size of the U.S. economy or historical inertia, but on the strength of U.S. institutions, the transparency of its policy framework, and the credibility of its governance.

The geoeconomic reality of 2025 creates a new environment:

• The U.S. is losing its image as a politically neutral arbitrator, undermining the dollar’s universality.

• Competitors are not replacing the dollar but are building regional networks of currency infrastructure.

• Investors and central banks no longer default to the dollar—they choose governance frameworks and institutional environments where assets are denominated.

In this context, the dollar:

• Is no longer a “ticket to the system,” but one of the platforms enabling global capital management,

• Must earn its role through legal credibility, policy predictability, and the independence of core institutions (Fed, Treasury, courts).

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🔁 For Global Investors, This Means:

• Moving beyond binary thinking: “Dollar or alternative,”

• Embracing active FX exposure management,

• Embedding jurisdictional and institutional analysis into strategic decisions.

In short, the dollar remains essential—but it must be a justified choice, not an assumed one.
Not hegemony, but trust. Not inertia, but functionality.
The future of currencies is no longer a hierarchy—it is a competitive architecture.

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