The U.S. dollar, long considered the global financial system’s anchor, has recently faced an unexpected stumble, shedding as much as 10% of its value in the first half of 2025. This sharp decline has sparked a wave of debate and speculation about whether the dollar’s reign as the world’s reserve currency is coming to an end. However, while this drop is noteworthy, it’s not unprecedented—the dollar experienced a similar decline in 2017. So, what exactly drives these fluctuations in the dollar’s strength? Is this the beginning of a long-term trend, or just another market blip?
Understanding Dollar Strength: Beyond Conventional Wisdom
“It’s an age-old question,” says Zhengyang Jiang, an associate professor of finance at Kellogg School of Management. Traditionally, the U.S. dollar is viewed as a safe-haven currency, appreciated in times of economic uncertainty and business cycle downturns. However, Jiang and his colleagues believe this conventional wisdom falls short when trying to explain long-term shifts in the dollar’s strength. To get to the root of the issue, Jiang and his collaborators at New York University and the Federal Reserve Board developed a new valuation model that incorporates two decades of datafrom the International Monetary Fund (IMF). Their model dissects the dollar’s strength into fundamental, quantifiable components, or “primitives,” to determine what factors are driving the dollar’s behavior.
“We’re not the first to study dollar strength in these terms,” Jiang acknowledges, “but we aim to provide a comprehensive analysis, quantifying how multiple factors come together to explain the dollar’s behavior.”
The Two Pillars of Dollar Strength: Demand and Savings
The team’s research reveals a striking conclusion: over 90% of the dollar’s strength is driven by just two key components:
Global Savings – the total amount of currency held by major financial institutions, corporations, and central banks around the world.
Investor Demand – the appetite of global markets for purchasing dollar-based assets, such as U.S. Treasury bonds.
Their model found that fluctuations in investor demand account for a significant 55% of the dollar’s strength, with global savings contributing 36%.
The model also explores what would happen if a major global player, such as China or the European Union, were to suddenly sell off its U.S. dollar holdings. Surprisingly, the effect on the dollar would be minimal. Even a massive sell-off by a major economy would only cause a 2.5% depreciation of the dollar. This suggests the dollar’s resilience is far stronger than many initially thought.
However, the real risk comes from a widespread decrease in demand for U.S. assets. If multiple major economies simultaneously reduced their holdings of dollar-based assets, the dollar could experience a 25% depreciation, jeopardizing its position as the world’s dominant reserve currency.
The Role of Monetary Policy: A Minor Influence on Long-Term Trends
One of the more surprising findings of Jiang’s study is that monetary policy—specifically, changes in U.S. interest rates—has a relatively minimal impact on the dollar’s long-term strength. While the Federal Reserve’s interest rate decisions do influence the dollar’s value on a short-term basis, their long-term effect is limited. For example, a one percentage point increase in interest rates by the Federal Reserve could lead to a 3.3% appreciation in the dollar, but these effects tend to normalize over time.
“This challenges the conventional wisdom that interest rate changes are the primary driver of the dollar’s strength,” says Jiang. “The long-term fluctuations in the dollar are more likely driven by shifts in demand and savings, rather than the ups and downs of short-term interest rate adjustments.”
What Happens if Demand for U.S. Assets Drops?
A key question emerging from Jiang’s research is: what if global demand for U.S. assets were to diminish? Could the dollar’s “specialness”—its unique status as the world’s reserve currency—be threatened? Surprisingly, the model suggests that even if China, a major buyer of U.S. Treasury bonds, were to sell off its holdings, the impact on the dollar would be relatively small—just a 2.5% depreciation. The real danger comes from a coordinated global shift away from U.S. assets. If multiple economies reduced their dollar holdings at the same time, the dollar could face a substantial decline.
However, Jiang notes that the dollar’s “specialness” has historically proven resilient. “If one major player like China or Europe sells off their holdings, the demand for dollar assets tends to be elastic,” he explains. “Other economies quickly step in to purchase these discounted assets, stabilizing the dollar.”
Lessons from History: Is the Dollar’s Reign Over?
The question remains: could the U.S. dollar’s dominance be coming to an end, much like the Dutch guilder and British pound sterling before it? The model highlights a key historical precedent: between 2002 and 2007, the dollar depreciated by 25%, largely due to a global shift in investment preferences toward riskier foreign assets. However, the 2008 global financial crisis caused a “flight to safety”, momentarily boosting the dollar’s strength.
While the dollar has rebounded in recent years, this new research points to the idea that a decline in investor confidence—such as a global disillusionment with U.S. financial assets—could weaken the dollar significantly. Indeed, Jiang observed a surprising 6.5% drop in the dollar’s value from April 1 to 21, 2018, following tariff announcements by the Trump administration, even amidst rising interest rates.
This indicates a potential waning confidence in U.S. Treasury bonds, which traditionally act as a safe-haven investment. “This time is different,” Jiang and his colleagues concluded. If global confidence in U.S. debt continues to erode, the dollar could face a severe depreciation, signaling a potential shift in global financial dynamics.
The End of an Era or a Temporary Setback?
Is the dollar’s reign coming to an end, or is this just another cyclical decline? Jiang and his team stress that it’s still too early to tell. While the dollar’s strength has fluctuated throughout history, its “specialness” has largely held firm. However, as global economic conditions evolve, the possibility of a permanent shift away from the dollar as the world’s reserve currency cannot be ruled out entirely.
The market has already begun responding to the shock of diminished confidence in U.S. assets, but whether this will turn out to be a temporary setback or a more profound, long-term trend remains uncertain. As Jiang puts it, “It’s unclear if this is going to be permanent or transitory.” Only time will tell.
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