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This overlooked risk to financial markets usually lurks quietly under the surface. But now it''s ''shouting, not whispering''

The Hidden Risks Lurking in America's Financial Dominance: Why the US Dollar's Strength Could Be Its Undoing

In the ever-shifting landscape of global finance, the United States has long enjoyed an enviable position as the issuer of the world's reserve currency. The US dollar's dominance facilitates everything from international trade to investment flows, allowing America to borrow cheaply and sustain massive deficits without immediate repercussions. However, beneath this veneer of stability lies a growing vulnerability that could upend financial markets. Recent data on the US net international investment position (NIIP) and the persistent current account deficit paint a picture of mounting risks, potentially leading to a sharp dollar correction, higher borrowing costs, and broader market turbulence. As we delve into these indicators, it becomes clear that the very privileges afforded by the dollar's status may be sowing the seeds of future instability.

At the heart of this concern is the US net international investment position, which measures the difference between the value of US-owned assets abroad and foreign-owned assets in the United States. In essence, it's a snapshot of America's financial standing with the rest of the world. According to the latest figures from the Bureau of Economic Analysis, the US NIIP has deteriorated to a staggering negative $20 trillion—equivalent to roughly 80% of the country's annual GDP. This negative balance means that foreigners own far more in US assets, such as Treasury bonds, stocks, and real estate, than Americans own overseas. While this has been a longstanding trend, the pace of deterioration has accelerated in recent years, driven by factors like surging government spending, trade imbalances, and the allure of US markets to global investors.

The NIIP's decline is inextricably linked to the US current account deficit, which tracks the nation's trade in goods, services, and investment income. For decades, the US has run substantial deficits, importing more than it exports and relying on foreign capital to bridge the gap. In the most recent quarter, the deficit widened to over $250 billion, or about 4% of GDP, fueled by strong domestic consumption, a robust dollar that makes imports cheaper, and energy independence that hasn't fully offset manufacturing offshoring. This deficit isn't inherently problematic—it's often financed by selling US assets to willing foreign buyers, who view them as safe havens. But herein lies the rub: as the deficit persists, it erodes the NIIP further, creating a dependency on continuous inflows of foreign capital.

Economists have long warned about the sustainability of this model, invoking the Triffin dilemma—a concept coined by Belgian-American economist Robert Triffin in the 1960s. Triffin argued that the issuer of the world's reserve currency must run deficits to supply the global economy with liquidity, but those very deficits undermine confidence in the currency over time. Today, this dilemma is playing out in real time. The US benefits from what former French Finance Minister Valéry Giscard d'Estaing famously called the "exorbitant privilege" of the dollar, allowing it to borrow at low interest rates and print money to fund deficits. Yet, as the NIIP plunges deeper into the red, investors are starting to question whether this privilege is sustainable. A sudden loss of confidence could trigger a "sudden stop" in capital inflows, forcing the US to abruptly adjust by devaluing the dollar or hiking interest rates to attract funds.

The risks to financial markets are multifaceted and far-reaching. First, there's the potential for dollar depreciation. If foreign investors, particularly central banks holding trillions in US Treasuries, begin diversifying away from dollar-denominated assets—perhaps toward euros, yuan, or even cryptocurrencies—the greenback could weaken significantly. Historical precedents abound: during the 2008 financial crisis, the dollar initially strengthened as a safe haven but later faced pressures from ballooning deficits. More recently, in the post-pandemic era, inflationary pressures and aggressive Federal Reserve rate hikes have bolstered the dollar, but underlying imbalances persist. A depreciating dollar would inflate import costs, stoke domestic inflation, and erode the purchasing power of American consumers and businesses.

Second, a worsening NIIP could lead to higher US interest rates as the government competes for scarcer foreign capital. With the national debt already exceeding $35 trillion, any uptick in borrowing costs would strain federal budgets, potentially forcing cuts in spending or tax hikes—moves that could dampen economic growth. For equity markets, this scenario spells trouble: higher rates typically compress stock valuations by increasing the discount rate on future earnings. Sectors like technology and real estate, which have thrived on cheap money, would be particularly vulnerable. Bond markets, too, face risks; a sell-off in Treasuries could spike yields, reminiscent of the 1994 bond market massacre when unexpected Fed tightening caught investors off guard.

Geopolitical factors amplify these risks. The US dollar's weaponization through sanctions—against Russia, Iran, and others—has prompted a global push for de-dollarization. Countries like China and India are increasingly settling trades in local currencies, while the BRICS bloc explores alternatives to the dollar-dominated SWIFT system. If these efforts gain traction, the demand for US assets could wane, exacerbating NIIP pressures. Domestically, political gridlock over fiscal policy adds another layer of uncertainty. With partisan divides stalling efforts to address entitlement spending or trade policies, the current account deficit shows no signs of narrowing. The Biden administration's infrastructure investments and the Trump-era tax cuts have both contributed to fiscal expansion, but without corresponding revenue measures, the imbalance grows.

Experts are divided on the timeline and severity of these risks. Optimists point to the US economy's resilience, its innovative edge, and the lack of viable alternatives to the dollar. "The dollar's dominance is entrenched," argues one Wall Street strategist, noting that over 60% of global reserves are still held in dollars. Pessimists, however, warn of a tipping point. Renowned economist Nouriel Roubini, known for predicting the 2008 crash, has likened the current setup to a "house of cards," suggesting that a combination of high debt, geopolitical tensions, and climate-related disruptions could precipitate a crisis. Recent simulations by the International Monetary Fund model scenarios where a 10% drop in foreign demand for US assets leads to a 5% GDP contraction and a 20% stock market plunge.

For investors, navigating this landscape requires vigilance. Diversification into non-dollar assets, such as emerging market equities or commodities, could hedge against depreciation risks. Policymakers, meanwhile, must prioritize reforms: boosting exports through targeted trade deals, enhancing domestic savings rates, and addressing fiscal sustainability. Without action, the US risks a disorderly adjustment that reverberates globally.

In conclusion, the interplay between the US dollar's strength, the deteriorating NIIP, and the chronic current account deficit represents a slow-burning threat to financial stability. While the system has held up remarkably well thus far, history teaches that imbalances of this magnitude rarely resolve painlessly. As global economic dynamics evolve, the era of unchecked American financial privilege may be drawing to a close, urging a reevaluation of assumptions that have underpinned markets for generations. The question is not if, but when, these risks will materialize—and how prepared the world is to handle the fallout. (Word count: 1,048)

Read the Full Fortune Article at:
[ https://fortune.com/2025/06/28/financial-market-risk-us-dollar-net-international-investment-position-current-account-deficit/ ]