In the film Oppenheimer, the scientists discuss the possibility that the Trinity atomic test could destroy the world. They conclude that the chances are ‘near zero’. “Zero would be nice,” responds the alarmed General Groves character.
A few weeks ago, one would have said that the chances of the US dollar losing its reserve currency status was zero. The characteristics of a reserve currency include:
Stability: A reserve currency needs to maintain its value over time, avoiding significant fluctuations.
Liquidity: It should be readily available and easy to trade, allowing for large quantities to be bought or sold without significantly impacting its price.
Economic strength: A reserve currency is typically issued by a country with a large and robust economy, playing a significant role in global trade and finance.
Financial Market: The country issuing the reserve currency should have a large, open, and deep financial market that facilitates international transactions and investments.
International Trade: The currency should be widely used for international trade and payments, making it an essential tool for global transactions.
Other factors: The credibility of the issuing country's policies, its openness to foreign investment and its role in international financial networks also contribute.
Only the US can claim to have all those features.
However, one or two cracks have appeared since president Donald Trump began his second term. In particular, the credibility of the issuing country’s policies and its openness to foreign investment might be seen by many people as challenges to US hegemony.
Credibility is difficult to define but the size and breadth of the tariff policies verbalised by the president is clearly, to be kind, unconventional. It threatens to unsettle relations with allies such as Canada, Mexico, Japan, Taiwan, and the European Union.
This, in turn, could see overseas governments and private sector investors looking for alternative locations for investing their capital.
For example, it is estimated that the 11 largest Asian economies have bought a cumulative $4.7trn of US equities and bonds since the 1997 Asian crisis. Japan is the largest investor with an estimated $1.8trn. The People’s Republic of China (ex Hong Kong) has $1.1trn.
There have been signs for some time that the PRC was reducing allocations to the US, but it is possible that other Asian governments and investors may do the same if Trump follows through with high tariff levels.
There are also other “soft” policies that show a hostility to foreigners. The latest is the State Department ordering US embassies not to make any new appointments for student visa applicants. The administration is also exploring increased vetting of social media accounts for overseas students applying to US universities.
This is part of an attack on US universities that has also included freezing billions of dollars aimed at research. Harvard has $9bn of Federal government grants and contracts frozen.
This has led several top universities to issue bonds, commercial paper and take out private loans to raise money. Over $4bn has been raised by nine of the top schools including five in the Ivy League, MIT, and Stanford.
If fewer foreign students attend US universities in the coming years that will diminish what has been an important contributor to the leadership America has had in many areas, including technology research, academia and the private sector.
There are also indications that the administration is willing to enact policies that will discourage foreign portfolio investment. Clearly tariffs are aimed at encouraging physical investment in factories and workplaces by companies that had been operating overseas.
But in the budget passed by the House of Representatives there are increases in withholding taxes on portfolio investments made by individuals or institutions from countries deemed to have tax policies that are discriminatory to US companies. Digital services taxes are a prime target of this policy.
So, there are, on the margin, policy initiatives that are contrary to behaviours one would expect from the printer of the global reserve currency. But we would not regard this as enough to threaten the dollar’s status.
There is, however, a factor in what makes a reserve currency that has not been mentioned. The global reserve currency has historically been printed by the world’s preeminent military power. This was true of the UK in the 19th century and into the 20th century. It has been true for the US since 1945.
At a time when the US is potentially going to use military power against Iran it would appear strange to suggest that a contributing factor to the possibility of the dollar losing its reserve currency status is that US military dominance is waning because of advances in military technology.
It has not been reported with as much prominence as one feels it should have been, but in the recent short-lived outbreak of hostilities between India and Pakistan there were some disturbing developments for countries reliant on Western military hardware.
India was armed with state-of-the-art Rafale jets made by Dassault Aviation. Each plane costs around $250m. India also had Meteor missiles, made in Europe, which each cost around $2m.
Pakistan was armed by China with JF10 Fighters costing $40m and PF-15 missiles costing $150,000 each.
The Indian air force has not confirmed reports that at least two Rafale jets were shot down by missiles fired from JF10 Fighters, but it seems likely that that did indeed happen. The missiles fly at four times the speed of sound and are electronically guided with a range of three hundred kilometres.
If the cheaper Chinese equipment did indeed get the better of the expensive Western equipment, this has serious implications. In particular, the best example of US hard power is its 11 carrier strike groups that patrol the oceans and, up until now, are presumed to give the US military supremacy in the areas they are operating in.
Hence the coverage of movement of the USS Nimitz from Asia to the Middle East on June 16th.Each aircraft carrier has 80 or so aircraft on it. But if hypersonic missiles can down Rafale jets in India they can down jets based on aircraft carriers (which include a model of the Rafale). That suggests the aircraft carrier is not necessarily the guarantor of US hard power that it has been for over 80 years.
Analysts at Clarmond Wealth pointed out there are parallels here to the Battle of Taranto in November 1940, when British planes launched from an aircraft carrier used torpedoes to cause severe damage to an Italian fleet at anchor in the harbour. Three battleships were disabled, and three other ships were badly damaged.
This heralded the era that we have been living in since, where naval aviation would always get the better of big-gun battleships. Arguably, Taranto also served as a template for the Japanese attack on Pearl Harbour 13 months later.
It is possible that the events in the Indo-Pakistan conflict last month have heralded the next stage in the evolution of what military might looks like.
So, for all these reasons, something that was totally improbable at the beginning of 2025 is now something that needs to be at least considered. Even if ending the dollar’s reign as the world’s reserve currency could take a long time, and even if it does not actually happen, the chances of it happening are no longer zero.
We are not changing portfolio positioning because of this. But we have discussed whether this constitutes a tail-risk that merits spending a small amount on capital hedging, by purchasing an out-of-the-money call option on sterling relative to the dollar for example.
We do not hedge currencies in equity portfolios except in extremis (such as in 2022 when sterling fell close to parity with the US dollar). But we do have tail-risk hedges on quite frequently and this would be another one. We will report on this matter again if we do that.
Bill Dinning is chief investment officer at W1M Investment Management. The views expressed above should not be taken as investment advice.