India needs dollars to pay for imports from the US. But we also need dollars to pay for imports from Europe, China, the Middle East—indeed, from almost everywhere. So does nearly every country. As a result, we try to run a trade surplus with the US, or we attempt to attract dollars through capital investments from foreign funds. And so do other countries.
The net result is that the US is forced into a deficit with most countries. This doesn’t mean the US is an injured party suffering to promote world trade. Quite the opposite—the US enjoys a unique privilege. When it runs a deficit, it merely prints dollars. After all, countries don’t hold their dollars as cash. They invest them in US government bonds.Thus, the US government runs up a fiscal deficit, issues bonds, and other countries buy them, enabling the US to finance both its fiscal and trade deficits at virtually no cost. It only pays the interest. Most countries envy this enormous advantage of the US.
French Finance Minister Valéry Giscard d’Estaing famously called it “the exorbitant privilege.” Economist Barry Eichengreen put it more starkly:
“It costs only a few cents for the Bureau of Engraving and Printing to produce a $100 bill, but other countries have to pony up $100 of actual goods and services in order to obtain one.” – Prof Barry Eichengreen
Understanding the disadvantage for the US
The disadvantage for the US is that every country wants to devalue its currency against the dollar. This becomes especially painful during economic downturns, such as wars or global financial crises. Typically, global investors flee to the safest asset—the US dollar. So, the dollar strengthens during crises, making recovery harder for the US.
Another major drawback is that US manufacturers lose competitiveness as rival countries keep their currencies artificially low. Germany and Japan outclassed US manufacturers from the 1960s to the 1980s. Since the 1990s, China has significantly eroded US manufacturing, in part by keeping the yuan undervalued.
But let’s go back to how the US dollar became the world’s exchange currency. A globally accepted currency became increasingly necessary after the First World War, as industrialisation and improved transport systems boosted global trade.
Until the Second World War, countries settled trade through the British pound, gold, or—in the case of French colonies—the French franc. But post-WWII, Europe was so devastated that the US dollar became the de facto medium of exchange.
Nixon era and the end of the gold standard
Under the Bretton Woods system, the US promised to back every dollar with an equivalent amount of gold, at a fixed rate of $35 per troy ounce. However, by the 1960s, the US had begun printing dollars recklessly—partly to fund the Vietnam War and other anti-communist campaigns and partly to support rising global trade. Eventually, it ran short of gold to back every dollar. In 1971, President Richard Nixon ended the gold standard and dismantled the Bretton Woods system.
A floating exchange rate system replaced Bretton Woods. But the dollar remained the global reserve currency, and the need to run deficits continued. Through the 1970s and 1980s, Japanese—and, to some extent, German—goods began outcompeting US products, even within the American market. Mounting deficits once again became a burden for the US.
In 1985, the US strong-armed Japan and Europe, particularly Germany—into signing the Plaza Accord, which forced them to appreciate their currencies against the dollar. As a result, the dollar depreciated by over 25% within a year against these currencies.
What is different in 2025 vs 1985?
Now, in 2025, we are witnessing a similar situation: US deficits are sky-high, and US manufacturing continues to be outclassed by Chinese goods. But this time, Trump doesn’t command the same clout the US held in 1985—especially over Japan and Germany, nations the US had once helped rebuild and protect post-WWII.
Also, central banks’ dollar reserves are no longer large enough to meaningfully distort markets through dollar selling. Global trade and financial markets have grown too vast for any central bank to significantly influence currency values. The US, therefore, resorts to bullying tactics —through threats of high tariffs—to reduce its deficit and attempt to bring back manufacturing to the US.
In its favour, it must be said that no viable alternative to the dollar as the global reserve currency has yet emerged. And here’s one more thought: if we are shocked by Trump’s sky-high tariffs and his erratic imposition and withdrawal of them, rest assured—this chaos is minor compared to the shock when the US ended the gold standard! That was monumental. We just don’t remember it because most of us weren’t around back then.
As for how high reciprocal tariffs will work to end US deficits while keeping the dollar as the reserve currency—well, that’s a discussion for another day.
