Moody’s, the last of the three major credit agencies to still believe in America, finally threw up its hands as if to say, Nope, not even we can spin this. It, too, has recently downgraded the U.S. government’s credit rating, from its top-tier triple-A status to double A1.
“Successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs,” according to Moody’s debt rating agency. “Over the next decade, we expect larger deficits as entitlement spending rises while government revenue remains broadly flat…. The U.S.’s fiscal performance is likely to deteriorate relative to its own past and compared to other highly rated sovereigns.”
In plainspeak: years after S&P and Fitch had already downgraded the U.S.’s fiscal outlook, Moody’s showed up late to the party, assessed the nation’s spending habits — which look a lot like a teenager maxing out their credit card — and reluctantly gave the country a worse review.
Moody’s decision, following similar actions by Standard & Poor’s in 2011 and Fitch in 2023, was driven by concerns over the U.S.’s growing $37.5 trillion debt balloon, and rising interest costs that threaten to collapse the dollar and usher in a global recession. Successive U.S. administrations have ignored the debt, to focus on problems that fit into the country’s four-year political cycle, thereby falling into uncharted waters.
The fallout
U.S. unpredictability has left world leaders stranded and walking on broken promises, in search of partners who can walk the talk. And they are finding them. Nations, once dependent on the U.S., are suddenly asking for separate checks.
In a stunning geopolitical twist, Japan and Canada, U.S. allies, have also diversified away from USD holdings via trade with each other instead of with the U.S. These two major U.S. allies have just established a new gas corridor between Canada and Japan, to maintain a multi-faceted global economy, independent of the U.S.
For Japan, securing a long-term energy supply from Canada reduces its dependency on existing energy routes and suppliers, many of which are U.S.-controlled or dollar-denominated. Did we just witness the geopolitical equivalent of a messy breakup? The rerouted natural gas represents not just a defiant shrug that says, “We’ve got options,” but a financial earthquake.
The U.S. downgrade
Think of Moody’s as the world’s least-amusing financial party pooper, and the U.S. credit rating as its report card. Now, imagine the former-triple-A U.S. trying to tell its frenemies, “Hey, you’re either with us or against us!” while holding a report card with a big, fat double A 1 on it: beneath a dozen other countries including Germany and Canada; now shoulder-to-shoulder with Austria and Finland. It’s a lot harder to be the cool kid on the block when you can’t afford to go out. Rifts with an increasing number of nations aren’t just a political headache — they’re another crack in the foundation of U.S. global influence, a crack that Moody’s has been forced to acknowledge. This comes with no other country in line to replace the USD as reserve currency.
But why would you want to?
A single reserve currency offers convenience, but it is a flawed arrangement with grave consequences. Yes, its issuer gains an “exorbitant privilege” ― to use the term coined by French Finance Minister and one-time president Valéry Giscard d’Estaing ― allowing it to fund domestic consumption with endless debt while exporting inflation and deindustrializing its own economy.
Yes, this power also doubles as a geopolitical weapon, subjecting other nations to the caprice of unilateral sanctions and exposing their economies to the volatile whims of a foreign central bank’s monetary policy. But the system’s greatest flaw is its inherent contradiction: to provide the world with enough currency for trade, the issuing country must run a persistent deficit, a self-defeating act known as the Triffin Dilemma that ultimately causes a debt balloon that erodes confidence in the very currency it seeks to preserve.
The nuts and bolts
Foreign countries acquire U.S. dollars for trade by selling their goods and services to the U.S. and then lending the dollars to the U.S. government by buying U.S. Treasury bonds. This debt is a key part of the global financial system and underpins the dollar’s status as the world’s reserve currency.
The largest exporter to the U.S. is usually the largest purchaser of U.S. Treasury bonds. When a country like China exports a large volume of goods to the United States, it gets paid in U.S. dollars. The Chinese companies that earn these dollars can either hold them or convert them into their local currency (the yuan). But the latter would cause their currency to become too strong, which would make their exports more expensive, so their central banks often buy up the U.S. dollars from their domestic companies to stabilize their currency’s value.
These central banks now have a massive stockpile of U.S. dollars. Rather than just holding onto cash, they invest it. U.S. Treasury bonds were the ideal choice because they upheld their triple-A credit ratings as one of the safest investments in the world. By buying these bonds, foreign central bank effectively lent money to the U.S. government.
What it takes to be the world’s reserve currency
For a currency to rule the roost, it must be backed by a strong and resilient economy — a simple matter of scale. It also requires deep and liquid financial markets, where trillions can be moved without a ripple, unlike less robust contenders.
Central banks around the world hold the reserve currency to conduct international transactions and investments. To become and remain a global reserve currency, a nation’s currency must be seen as stable and trustworthy. Trust is built on a few key pillars. The issuing country must have strong, stable institutions and a reliable legal system to protect foreign investors’ assets from political interference. The currency itself needs to be freely convertible, meaning it can be easily exchanged without government-imposed capital controls.
Additionally, the country must maintain a consistent monetary policy managed by a credible central bank. This policy is a promise that the government will not recklessly print money to solve short-term problems nor devalue its debt through crypto, which would erode the currency’s value and undermine global confidence.
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Ultimately, the strength of a reserve currency is a measure of its issuer’s ability to be boringly reliable. Trust in the enforcement of law and agreements is the crux of the matter. When promises that politicians have campaigned on are not upheld, democracy breaks down. No one wants to be caught holding the currencies of countries where the politicians are unpredictable, and assets are repurposed.
Before the World Wars, the British pound sterling was the world’s reserve currency. It was the undisputed leader of global finance, backed by the strength of the British Empire and the City of London’s dominance in trade and banking. The world’s central banks held vast reserves in sterling, and it was the primary currency used for international transactions.
The two World Wars, however, proved to be a fatal blow to the pound’s standing. World War I strained the British economy to its breaking point. To finance the war, Britain accumulated an enormous amount of debt, much of it from the United States. This fundamentally shifted the balance of financial power.
World War II was even more devastating. Britain again needed significant financial assistance from the U.S., which was becoming the new industrial powerhouse. The war left Britain heavily indebted and its economy weakened, no longer able to support the vast global financial system it had once led.
The American dollar’s sheer size gave it a built-in advantage, and it became the world’s reserve currency. Now, to meet foreign demand for the reserve currency, the U.S. must constantly supply dollars to foreign countries for their transactions. This service of dollars greases the wheels of international commerce. The most direct way for the U.S. to inject dollars into the global economy is by buying more goods and services from foreign countries than it sells. When the U.S. imports more than it exports, dollars flow out of the country. These dollars are then held by foreign central banks and governments as reserves, or they are used to finance international transactions.
Exorbitant privilege, or Pandora’s box?
But now the $37.5 trillion in U.S. debt is out of control. Maybe that’s why no one’s lining up to take its place as reserve currency provider. Who wants to run that kind of trade deficit if it guarantees eventual erosion in the currency’s value? So far, no other country has stepped up to drown in all that debt. Even the U.S. is trying to replace the dollar as reserve currency, with “Stablecoin,” a denomination that will be linked to U.S. Treasuries’ debt.
At the same time, modern payment systems mean the world might not need a single reserve currency. Outside of the reserve-currency box, BRICS countries are working on the creation of a sanctions-proof, multipolar financial system. By encouraging the use of the Chinese yuan alongside other major currencies like the euro, BRICS aims to create a more balanced financial order, no longer dominated by a single currency.
Running nowhere
So the exorbitant privilege of running up debt isn’t as appealing as it might seem. The industry is beginning to suspect that no one would be foolish enough to want the job.
The solution for the U.S. isn’t to stop trading with the rest of the world, but to embrace a fiscally viable path. It’s time to put the brakes on the exorbitant-privilege engine running up debt, get out, and walk the beaten path to a healthy future.
Editor’s Note: The opinions expressed here by the authors are their own, not those of Impakter.com — Cover Photo Credit: Adam Nir.
