Gambling with the dollar’s future

US Federal Reserve fueled this cycle by keeping its policy rate “low for long” after the 2008 global financial crisis. For too many, “long” was interpreted as “forever.” They simply took it for granted that US growth would be consistently higher than the real interest rate on government debt, which itself would remain exceptionally low by historical standards.

After all, despite the ballooning debt stock, the Congressional Budget Office (CBO) determined that the government’s net interest outlays as a share of GDP were lower in 2021 than two decades earlier.But will the rest of the world continue to enable US politicians’ addiction to the exorbitant privilege? Foreign holdings of US Treasury debt accounted for around 13% of the outstanding stock in the early 2000s, and that share climbed to about 37% by early 2013, owing to China’s spectacular build-up of foreign-exchange reserves during its era of double-digit growth. But that was the peak, and the share has been declining ever since, to around 22% at the end of 2024.The US dollar was appreciating throughout most of that period, so the reversal of the trend cannot be explained by valuation effects alone.Rather, the growth of US fiscal deficits and the surge in new debt issuance significantly outpaced foreigners’ appetite for US Treasury securities (and the growth in foreign purchases has been anything but steady in recent years).To be sure, the diversification in foreign portfolios away from dollars has not yet produced the oft-mentioned doomsday scenario: a massive sell-off of Treasuries that would paralyze global capital markets and spark another round of bankruptcies and financial crises.