Trade War and the Dollar Anchor

Our research develops a framework to understand why the dollar has emerged as a global safe-haven and anchor currency and how this role might change under a nationalist trade policy. Our analysis yields two key insights: First, the United States enjoys several financial privileges stemming from the dollar’s status as the global safe-haven currency. These include the dollar’s position as the world’s anchor currency, the relatively low yields on government debt, firms’ ability to borrow cheaply in global financial markets, and the country’s ability to attract a disproportionate share of international investment. Second, the dollar’s safe-haven property, in turn, depends on the link between the US economy and the rest of the world through free trade. A trade war that isolates the United States from global markets severs this link. By reducing the extent to which economic developments in the United States affect world markets, tariffs erode the dollar’s safe-haven status and the associated financial privileges.

At the heart of our framework is the premise that international trade helps countries cushion themselves against domestic economic developments. When a country experiences reduced supply or a surge in demand, its currency appreciates, so its residents purchase more imports. Thus, countries effectively cushion one another by shipping goods to wherever they are most needed. In this respect, all countries behave alike. However, since the United States is the world’s largest economy, a larger share of the world’s tradable goods is needed to satisfy Americans’ increased demand for imports when the dollar appreciates. This makes traded goods scarce worldwide and thus more expensive. The dollar, therefore, appreciates when resources are scarce globally.

The fact that the dollar gains value in times of global stress makes it a safer store of value than the currencies of other countries. Consequently, international investors prefer holding bonds denominated in US dollars, giving rise to the United States’ so-called exorbitant privilege: Because the dollar has a lower interest rate, Americans can borrow relatively cheaply in world markets. For the same reason, investing in US firms becomes more attractive, their value in international markets rises, and capital flows disproportionately to the United States.

The dollar’s safety premium also incentivizes smaller economies to stabilize their exchange rates by tying their currencies to the dollar: When a country’s currency moves in tandem with the dollar, it becomes safer in the eyes of global investors. This raises the value of firms in dollar-stabilized countries along with their domestic investment and wages. Tying their exchange rates to the US dollar thus helps smaller economies attract international investments. Therefore, our framework explains why the vast majority of countries voluntarily stabilize their currencies by pegging them to the US dollar, placing the dollar at the center of the international monetary system.

Next, our research examines how a trade war disrupts this system. Our key finding is that inhibiting trade flows to and from the United States, through tariffs or other means, weakens the force underpinning the dollar’s special role. A trade war that isolates the United States from global goods markets erodes the link between the dollar’s value and the world-market price of traded goods. By restricting the flow of goods into and out of the United States, tariffs reduce the extent to which US economic developments affect global prices, diminishing the dollar’s tendency to appreciate during times of global stress. In the extreme, if the US were completely cut off from world trade, its economy would have no effect on global prices, and the dollar would behave like the currency of a small, isolated economy—one that faces higher interest rates, commands no safety premium, and gives other countries no reason to peg their currencies to it. Thus, the structure of the world monetary system depends on free trade between the United States and the rest of the world. Without free trade, the world’s anchor-currency system may shift to another currency or collapse entirely.

We assessed these possibilities using our framework, which we calibrated to closely match the structure of the world monetary system prior to President Trump’s April 2025 tariffs announcement: The United States, the eurozone, and a handful of other large economies were floating their exchange rates, while smaller countries pegged their currency to the US dollar to varying degrees. Our framework replicates the interest rate advantage of approximately 2.5 percentage points that the United States enjoys over small, developed economies.

After April 2025, the average tariff rate on US imports and exports jumped to 12–17 percent. US interest rates rose, stock prices fell relative to international stocks, and the volatility of the dollar spiked, all consistent with our framework’s predictions after imposing a trade war. If tariffs of this magnitude persist, our framework further predicts a significant weakening of the dollar anchor, with some countries loosening their stabilizations and others decoupling from the dollar altogether. More strikingly, our framework identifies a critical threshold: If average tariffs and retaliations exceed roughly 26 percent for an extended period, the entire architecture of the international monetary system could shift. At that point, small economies may find it optimal to tie their currencies to the euro rather than the dollar, thereby making the euro the world’s new primary anchor currency. This major shift would transfer the financial benefits of being the world’s anchor currency—lower interest rates, higher firm valuations, and greater capital inflows—from the United States to the eurozone. This shift would benefit Europeans, but well-being would decline for Americans. The message is clear: Open trade is necessary for the dollar to remain the center of global finance.

Note
This research brief is based on Tarek Alexander Hassan et al., “Trade War and the Dollar Anchor,” National Bureau of Economic Research Working Paper no. 34332, October 2025.