What will happen to the global market if the US dollar hegemony declines?

According to news from the Wind Trading Platform, on May 8, HSBC's senior economic advisor Stephen King released a report that examines the rise and fall of reserve currencies from a historical perspective, delving into the status of the US dollar as the world's reserve currency, and studying and analyzing the Trump administration's attitude towards the dollar's reserve status and its potential impacts.

The report shows that history indicates that "destroying a reserve currency is easier than creating one," and the collapse of the reserve currency system is often accompanied by significant economic turmoil and sharp fluctuations in asset prices, rather than a smooth transition to a new system.

King pointed out that certain members of the Trump administration are concerned about the burden that the dollar's current reserve currency status places on the US economy and are attempting to weaken the dollar's international standing through various measures. The report warns that this approach could trigger market instability—the success of a reserve currency partly depends on the issuing country’s willingness to sacrifice some economic sovereignty for greater overall economic benefits. Once the issuing country begins to believe that these economic benefits are offset by costs, it may adopt policies to suppress international usage.

From the collapse of the gold standard in the 1930s to the disintegration of the Bretton Woods system in the 1970s, these events were accompanied by significant economic and financial turmoil, with asset prices and exchange rates experiencing sharp fluctuations.

King believes that the US government's attempts to correct the "overvaluation" of the dollar could trigger financial turmoil, disrupt international capital markets, and raise questions about the Federal Reserve's ongoing commitment to dollar swap lines, the Fed's potential "fiscal dominance," and the US's continued support for Bretton Woods institutions (which have long helped establish the "rules of the game" for the international economy and finance).

HSBC believes that if the US attempts to "reclaim" control over the dollar, meaning the Federal Reserve is no longer willing or able to continue acting as the world's "lender of last resort," and global capital markets lose access to dollar swap lines, the risk will be a massive market shift towards gold, which has completely inelastic supply, leading to severe liquidity shortages, while gold prices continue to soar, potentially triggering financial turmoil similar to that of the 1930s or 1970s.

A Historical Perspective on the Decline of Reserve Currencies

The report first reviews the history of reserve currencies.

King points out that the issuing country of a reserve currency often sacrifices some economic sovereignty for international economic cooperation. He emphasizes that historical experience shows that negative policies designed to prevent the international use of a currency are more effective than positive interventions that encourage its use.

The report mentions the gold standard as an early reserve currency system, which limited a country's ability to "live beyond its means" through uncompetitive wage or price levels. As paper currency was linked to gold, and no country could alter the supply of gold, this loss of competitiveness would be reflected in a deterioration of the balance of payments, leading to gold outflows.

The report states that this outflow forced the domestic money supply to contract, thereby reversing the initial loss of competitiveness by lowering domestic prices and wage levels.

By the 1930s, the collapse of the gold standard had a tremendous impact on the world economy. In that context, to meet international demand, the Federal Reserve set extremely low interest rates, leading to a bubble in the US stock market.

The Collapse of the Bretton Woods System and the Recovery of the Dollar

After World War II, under the new international order, the dollar became the new reserve currency.

The report points out that beyond the IMF, World Bank, and the General Agreement on Tariffs and Trade (the predecessor of the World Trade Organization), the dollar became the "primary among primaries." The Bretton Woods Conference in 1944 established a new monetary system where the dollar could be exchanged for gold, while other currencies were pegged to the dollar.

However, the Bretton Woods system also exposed some key weaknesses. Some countries seemed to benefit from the fixed exchange rate arrangement, experiencing rapid economic growth and accumulating current account surpluses. Other countries appeared to continuously lose competitiveness and were prone to international balance of payments financing crises. The report notes that French Finance Minister Valéry Giscard d'Estaing described the dollar as America's "excessive privilege."

Ultimately, as the United States faced increased expenditures due to the Apollo moon landing program, wars, and rising inflation in the late 1960s, the dollar began to come under pressure. In 1971, the Nixon administration implemented the "Nixon Shock"—ending the automatic convertibility of the dollar to gold, imposing price and wage controls, and levying a 10% tariff on U.S. trading partners. The report argues that this marked the collapse of the Bretton Woods system.

In the 1970s, after the collapse of the Bretton Woods system, the world experienced significant turmoil. OPEC decided to quadruple oil prices, reflecting to some extent the unwillingness of oil-producing countries to accept payment in devalued dollars; although during this period, U.S. stocks performed better than U.S. bonds, investors experienced a rollercoaster market.

Gold prices soared from $35 per ounce in the early 1960s to between $500 and $850 per ounce.

The report notes that the dollar ultimately regained its role as the world's dominant reserve currency, partly due to the extraordinary domestic policy shift taken after Paul Volcker was appointed as Chairman of the Federal Reserve—Volcker implemented high interest rate policies that attracted international investors to dollar assets, leading to a strong appreciation of the dollar

The Trump Administration's Attitude Towards the Dollar May Be More Important Than Tariff Policy

The report further analyzes the potential impact of the Trump administration on the dollar's reserve status.

The report points out that while the Trump administration's tariff policy has dominated the headlines, its attitude towards the dollar's status as a reserve currency may be a bigger issue.

The report cites Stephen Miran's view that the current international trade and financial system has harmed the U.S. economy, and as the world's reserve currency, the dollar has become a burden on the U.S. because "as the U.S. shrinks relative to global GDP, the current account or fiscal deficits needed to fund the global trade and savings pool are increasingly large as a proportion of the domestic economy."

The report also notes that members of the Trump administration believe the dollar is "overvalued" and can be corrected through a series of measures, which would effectively redefine the dollar's role as a reserve currency. These measures may include:

Imposing sanctions on countries that hold dollar assets but seem to undermine Washington's strategic interests;

Using tariff policies to "encourage" countries to appreciate the dollar;

Encouraging other countries to restructure their holdings of U.S. assets in exchange for tariff reductions or continued U.S. security guarantees;

Asking the Federal Reserve to pay more attention to its rarely mentioned "third mandate," which is "moderate long-term interest rates";

Replacing Federal Reserve decision-makers with those more willing to closely cooperate with the Trump administration.

After the "Exit" of Dollar Hegemony, Will Global Capital Flow into Gold and Trigger Financial Turmoil?

King summarizes historical lessons in the report and predicts future trends. He believes that if the U.S. abandons or neglects the international institutions that previously set the "rules of the game," the credibility of these institutions will be difficult to maintain.

He argues that if the dollar is no longer trusted as the world's reserve currency, establishing a new reserve currency will neither be easy nor happen quickly.

The report further analyzes that if the U.S. attempts to "reclaim" control over the dollar, meaning the Federal Reserve is no longer willing or able to continue acting as the world's "lender of last resort," and global capital markets lose dollar swap lines, the risk will be a massive market shift towards gold, which has completely inelastic supply, leading to severe liquidity shortages, while gold prices continue to soar, potentially triggering financial turmoil similar to that of the 1930s or 1970s.

The report predicts that emerging economies may adopt a "safety first" approach to balance their international payments, which could lead to a decline in global total demand. The report suggests that if the U.S. government fails to create manufacturing jobs, this policy may ultimately be disappointing