Currencies – The Emerging Markets Investor

The U.S. dollar: From Public Good to Private Weapon

“China needs to build a powerful currency that could be widely used in international trade, investment and foreign exchange markets, and attain reserve currency status,” Xi Jinping, January 2026

The hegemony of the United States dollar has long been the bedrock of global economic stability, functioning as a “global public good” that facilitates seamless trade and investment. However, two seminal 2026 papers published via the Carnegie Endowment for International Peace suggest that this foundation is beginning to crack. In “The US Dollar System as a Source of International Disorder,” (Link) Daniel Davies and Henry Farrell argue that the strategic weaponization of the dollar has transformed it from a stabilizing force into a primary driver of global friction. Complementing this view, Alexander Evans’ “The Hollow Dollar?” (Link) explores the internal structural decay of the currency’s institutional reliability. Together, these works present a troubling portrait of a financial superpower at a crossroads, where short-term geopolitical leverage may be coming at the cost of long-term systemic integrity.

From Homeostasis to Disorder

Davies and Farrell frame the post-WWII financial system as originally homeostatic—meaning it possessed self-regulating feedback loops that maintained stability even when faced with external shocks.

The Original Goal: Dollar centrality (using the dollar as the “vehicle currency” for global trade) was intended to lower transaction costs and create a predictable environment for all nations.
The Shift: After 9/11, the US began “weaponizing” this centrality. By controlling the “plumbing” of global finance—such as the SWIFT network and dollar clearing banks—the US gained the power to sever adversaries from the world economy.

The “Weaponization” Feedback Loop

The core of their paper describes a dangerous cycle that has replaced the old stability:

Exploitation: The US leverages dollar centrality for national security (e.g., aggressive sanctions on Russia, Iran, or North Korea).
Circumvention: Fearing they might be the next target, other countries—including allies like the EU—take steps to evade US power by building alternative payment systems or diversifying reserves.
Escalation: The US perceives this evasion as a threat and “doubles down,” scaling up financial coercion to force countries back into the system.

“The more that other countries look to escape US financial coercion, the more the US will scale it up to pin them into place.”

Key Disruptors: Private Actors and Tech

Farrell and Davies highlight two modern factors accelerating this disorder:

Bank Over-Compliance: Terrified of US fines, global banks have adopted “zero-risk” policies. This “de-risking” often cuts off legitimate businesses in developing nations, fueling resentment and the search for alternatives.
Cryptocurrency & Digital Assets: The introduction of US-backed stablecoins and other digital assets provides new, less-regulated avenues. While these make the system harder for the US to control, they also increase overall volatility.

The Structural Decay: “The Hollow Dollar?”

While Davies and Farrell focus on strategic breakdown, Alexander Evans focuses on structural decay. Evans argues that while the dollar still appears dominant on the surface, it is becoming “hollow.”

The Illusion of Centrality: High reserve percentages are “lagging indicators.” The dollar’s utility is declining as “mini-systems” (like BRICS-pay or the digital yuan) handle more local trade.
Decoupling from Values: As US domestic politics become more volatile and transactional, the dollar loses its “safe haven” status and its identity as a global public good.
The “Sudden Snap” Risk: Evans suggests the dollar will not decline gradually. Like a hollowed-out structure, it may maintain its form until a specific crisis causes it to “snap” due to a lack of internal trust.

Conclusion

The synthesized findings of Davies, Farrell, and Evans suggest that the US is currently trading its long-term financial credibility for short-term geopolitical wins. If the dollar system is indeed a “source of disorder,” then the “hollow dollar” is the inevitable, fragile result. By treating the global financial infrastructure as a bureaucratic weapon of first resort, the United States risks incentivizing a multipolar world split between incompatible currency blocs. Ultimately, if the US continues to prioritize coercion over the maintenance of a rules-based order, it may find itself presiding over a fragmented global economy where the dollar remains central in name only, stripped of the trust that once gave it power.

The Transactional Turn: American Exceptionalism and the Rise of Mercantilist Imperialism

Throughout its history, the United States has transitioned between eras of systemic vitality and periods of structural malaise. These cycles dictate the direction of global capital, the strength of the dollar, and the ultimate trajectory of asset prices. For the past fifteen years, investors have benefited from a cycle of American vigor, fueled by technological dominance and energy independence. However, as these tailwinds fade, the United States is pivoting toward a “might-makes-right” transactionalism—a shift that fundamentally alters the pillars of American Exceptionalism and signals a transition into a new era of malaise.

Strategic Asset Allocation for the 2026–2030 Transition

As we move away from the “Vigor” phase, the following table summarizes how to reposition a portfolio for a world defined by a weakening dollar and rising geopolitical friction.

Current Exposure (Vigor)	Strategic Shift (Malaise)	Rational
U.S. Growth / NASDAQ	International Value / EM	Captures growth in regions with lower valuations and better demographics.
Long-Duration Bonds	Commodities & Real Assets	Protects purchasing power against dollar devaluation and structural inflation.
U.S. Dollar Cash	Hard Assets / Gold	Hedges against the erosion of the dollar’s “safe haven” status.
Global Tech Titans	Energy & Defense (Non-U.S.)	Positions for a world of increased military spending and resource scarcity.

The Era of Outperformance: 2012–2025

The United States rebounded from the Great Financial Crisis faster than the rest of the world (ROW) and sustained higher growth throughout the 2012–2025 period. Several key factors supported this U.S. outperformance:

Energy Independence: The exploitation of shale oil and gas resources converted the U.S. from a major hydrocarbon importer to a large-scale exporter.
Tech Dominance: The extraordinary profitability and cash generation of Silicon Valley’s “winner-take-all” global titans drove U.S. stock valuations back to the stratospheric levels seen during the TMT (Technology, Media, and Telecommunications) bubble.
Policy Support: Stimulative fiscal and monetary policies shielded the economy from deep recessions and boosted corporate profits.
Currency Strength: The persistent strengthening of the U.S. dollar lowered borrowing costs, suppressed inflation, and attracted foreign capital.
Labor Dynamics: High levels of immigration contributed to labor supply and helped maintain low inflation.

Conversely, growth in the Rest of the World was hampered by:

European Stagnation: Tighter financial conditions and recurring crises in Europe and emerging markets led to prolonged low GDP growth.
Geopolitical Instability: Brexit and rising political instability across Europe, exacerbated by the Russian invasion of Ukraine, necessitated vastly greater military spending.
China’s Slowdown: The end of China’s “Economic Miracle,” marked by demographic collapse, plummeting productivity, and a massive real estate bubble that eroded private savings and consumption.
Structural Shifts in Beijing: The radicalization of Chinese domestic and foreign policy under Xi Jinping, which prioritizes Communist Party control and economic self-sufficiency over consumption and growth.

The Transition to Malaise

Every cycle of American vigor is accompanied by a strong dollar, falling commodity prices, and rising domestic asset prices. Conversely, a cycle of “malaise” is typically marked by a depreciating dollar, rising commodity prices, and higher relative growth in the ROW. Historically, these phases are defined by the rise of a foreign power that symbolizes relative U.S. decline: Germany in the 1970s, Japan in the 1980s, and China in the 2000s.

The following chart depicts the U.S. Real Effective Exchange Rate (REER) over the past 60 years with the purpose of illustrating how dollar strength and weakness is intrinsically linked with the long-term cycles of vigor and malaise of the U.S economy. The connection exists because both these cycles are linked to capital flows, interest rates and growth rates.

We are now entering a transition from vigor to malaise. The drivers of the 2012–2025 expansion have largely pivoted:

Shale Plateau: The shale boom has matured, and production is expected to plateau at current levels.
Tech Maturity: Tech margins and valuations are at historic highs, while capital intensity is increasing.
Fiscal Constraints: Record-high government debt and elevated interest rates are raising serious concerns regarding fiscal deficits.
Dollar Reversal: The U.S. Real Effective Exchange Rate (REER) peaked in January 2025 after appreciating 55.2% from its 2011 bottom—surpassing peaks in 1970, 1985, and 2002. Just as the 1970 high led to the end of Bretton Woods and the 1985 high prompted the Plaza Accord, the current overvaluation has become a political target. Under the Trump Administration’s pressure, the dollar has already lost 5% of its value in 2025.
Border Policy: Immigration policy has shifted from an “open door” approach to strict control.

The Erosion of Exceptionalism

Beyond economics, the Trump Administration has challenged the traditional pillars of “American Exceptionalism.” Both domestic and foreign policies have shifted from values-based leadership to a transactional, “might-makes-right” framework:

The End of Pax Americana: The retreat from global alliances has diminished the U.S. ability to shape the rules-based order and maintain a dollar-centric financial system. Just in recent weeks we have seen “middle powers” seeking alternative partnerships that bypass U.S. arbitrariness, such as Canada’s trade agreement with China, Europe’s trade agreement with Mercosur and Korean rapprochement with China and Japan.
Academic Decline: Policies are undermining the capacity of American universities to conduct world-class research and attract global talent.
Institutional Erosion: The undermining of the “checks and balances” inherent in the federal system and the perceived weaponization of the Department of Justice have threatened the traditional U.S. rule of law.

Investment Implications for the New Cycle

As the drivers of U.S. outperformance pivot, the investment playbook must shift from a “US-only” growth focus to a more diversified, value-oriented strategy. Investors should consider reducing exposure to high-multiple domestic tech titans in favor of ex-U.S. equities, particularly in markets that benefit from a weaker dollar and a resurgence in commodity demand. With the era of “cheap labor and cheap energy” ending, real assets—including commodities, gold, and infrastructure—likely offer better protection against the inflationary pressures of a devalued currency. Finally, given the rising fiscal deficits and the end of the “strong dollar” policy, a move toward shorter-duration fixed income or inflation-linked securities may be necessary to hedge against sovereign credit concerns and interest rate volatility.

A New Cycle for International Markets

American stocks have experienced a stratospheric rise since the Great Financial Crisis, while foreign stocks have languished. This long period of “American Exceptionalism” was marked by enormous inflows of foreign capital into the U.S., which boosted the value of the dollar and U.S. assets to altitudinous levels. However, recent political shifts and new market trends point to a tidal change that could lead to a sustained reversion in U.S. asset prices and a relative outperformance of international assets.

In recent American financial history, periods of “American Exceptionalism” have been followed by bouts of “American Malaise.” These cycles—from euphoria to despair and back—are typically marked by the relative GDP growth of the United States compared to the global economy. During periods of American Exceptionalism, strong U.S. GDP growth relative to the global economy is usually driven by political and technological trends. Conversely, during periods of American Malaise, relatively weak U.S. growth is typically driven by a reversion of previous trends and by the rise of foreign economic powers, such as Germany in the 1970s, Japan in the 1980s, and China and emerging markets in the 2000s. Importantly, these cycles have significant effects on monetary flows, currency valuations, and asset prices. During periods of American Exceptionalism, capital is attracted to the United States, driving up the value of the dollar and U.S. asset prices. During periods of American Malaise, capital flows out of the U.S. into foreign markets, driving their currencies and markets higher.

Since the mid-1960s—a period that includes the turbulence of the final years of the Bretton Woods dollar/gold fixed exchange rate system and over five decades of a U.S. dollar-centric fiat currency global monetary system—the U.S. has experienced three full cycles of sentiment, moving from pessimism to exuberance and back. Conveniently, these cycles can be marked by the rise and fall of the dollar in a fiat currency system such as the one we’ve had since 1971. The chart below highlights these four phases:

Cycle 1

American Malaise (1966–1980)
By the mid-1960s, both Europe and Japan had recovered from World War II, and the U.S. began to run current account deficits, leading some countries—such as France—to decry the “exorbitant privilege” enjoyed by the U.S. and to repatriate gold. This led President Nixon to end the convertibility of the dollar to gold in 1971, breaking the Bretton Woods system established in 1944. The collapse of the dollar and the stagflation of the 1970s ensued. This period of American Malaise was marked by the rise of Germany as an economic power and the embrace of the Deutsche Mark and gold as alternative “safe haven” assets. In 1979, President Carter’s famous “Malaise Speech” expressed a general feeling of national frustration and pessimism following Vietnam, Watergate, and the Iranian Revolution. He warned that “the erosion of our confidence in the future is threatening to destroy the social and political fabric of America.”

American Exceptionalism (1979–1986)
President Reagan (1981–89) embodied American Exceptionalism with his “Morning in America” rhetoric and his vision of America as a “shining city on a hill,” a moral lighthouse to inspire the world. An extremely hawkish monetary policy, executed by Fed Chairman Paul Volcker, triggered debt crises in Latin America and Eastern Europe, collapsed commodity prices, and set off huge capital inflows into U.S. assets, driving the dollar upward. The Plaza Accord in 1985 aimed to weaken the dollar through coordinated market intervention. Reagan also restrained Japanese car exports (1981), requiring automakers to build factories in the U.S. to maintain market share.

Cycle 2

American Malaise (1986–1992)
During the second half of the 1980s, Japan was heralded by magazines and best-selling books as the new economic power threatening U.S. hegemony. Japanese companies—such as Toyota, Sony, Panasonic, and Honda—were believed to be outperforming U.S. competition by being more efficient, more innovative, and offering better quality. This aura of Japanese dominance was punctuated by a wave of Japanese acquisitions of Western trophy assets, such as Rockefeller Center, Pebble Beach, and iconic Western artworks. Moreover, this was a period of strong recovery for emerging market economies, which once again attracted significant speculative capital. America’s despondency was further punctuated by the First Gulf War and a rise in oil prices, which drove the U.S. economy into recession and led to the election of President Clinton.

American Exceptionalism (1992–2001)
President Clinton (1993–2001) presided over a remarkable period of American Exceptionalism. The Cold War ended in 1991 with the collapse of the Soviet Union. Francis Fukuyama’s book The End of History (1992) expressed the widely held belief that Western liberal democracy and capitalism had permanently won the battle of ideas. The “peace dividend” allowed Clinton to cut defense spending from 6% of GDP to 3% and, along with tax increases, run fiscal surpluses from 1998 to 2001. The 1990s saw a productivity boom driven by the Information and Communication Technology (ICT) revolution—computers, software, and networking technology—and a stock market boom, particularly in tech and internet companies. Concurrently, emerging markets suffered a long series of financial meltdowns, beginning with Mexico in 1994, Asia in 1997, and Russia in 1998.

Cycle 3

American Malaise (2002–2012)
Clinton’s deregulation of the financial sector (the repeal of Glass-Steagall and deregulation of derivatives) laid the groundwork for the dot-com and housing bubbles, which burst in 2000 and 2007, respectively. The stock market crash and the Great Financial Crisis brought forth unorthodox monetary policies, which undermined the dollar and revived interest in gold. The accession of China to the WTO (2001) and the launch of the euro (2002) also sparked dollar outflows. China’s economic miracle (2000–2012) caused a commodity super-cycle and enormous inflows into emerging market assets, which created massive stock market and credit bubbles.

American Exceptionalism (2012–2024)
The GFC left most of the global economy in a semi-depressed state, including China, which was burdened with excess debt, a housing bubble, and diminishing returns on infrastructure investment. However, starting in 2012, the U.S. experienced a relative resurgence based on four pillars: (1) a rising dollar, (2) the shale oil revolution, (3) the remarkable success of its winner-take-all global tech titans, and (4) a cycle of fiscal expansion and debt accumulation. These factors led to massive inflows of capital into American financial assets and a singular “wealth effect” for America’s moneyed classes.

Cycle 4

American Malaise (2025–?)
President Trump has articulated a darkly negative vision of a country mutilated by elites—both domestic and foreign—who have “sold out the country” and caused “an American carnage” of crime, poverty, and decaying infrastructure. He aims to dismantle both domestic institutions (public programs, the courts, universities) and the American-led world economic order—its liberal foundations and its system of alliances—which has long buttressed American leadership and soft power. Unsurprisingly, Trump’s wrecking-ball tactics are unsettling investors and raising questions about the reliability of the U.S. as a partner in military, financial, business, and educational matters.

Initial reactions to Trump’s second-term agenda point to the start of a new phase of American Malaise. A weakening dollar, rising long-term interest rates, declining U.S. stock prices, and a surge in the price of gold indicate significant capital outflows from U.S. assets. Moreover, the drivers of the past decade of American Exceptionalism appear tired. First, the administration is ambivalent about the dollar’s reserve status and is considering measures (e.g., a new Plaza Accord) to bring it down from its high level. Second, the shale revolution appears to have peaked, with output now expected to stabilize. Third, high valuations, saturated markets, deglobalization costs, regulatory hurdles, and increasingly capital-intensive business models for the tech titans point to more moderate return prospects. Fourth, bond markets are showing low tolerance for further fiscal largesse.

A phase of American Malaise can be expected to last 5–10 years. Outflows from U.S. markets into foreign markets drive the dollar lower, raise commodity prices, and unleash credit, boosting GDP growth and asset prices outside the U.S. These flows create a virtuous cycle of rising confidence, growing liquidity, and higher asset prices abroad.

America First and Currency Wars

A month into the second coming of Donald Trump, the world is grappling with the meaning of his obsession with trade tariffs. Though it is highly unclear what the details of trade policy will be, it appears the primary objective may be to force global firms to reshore manufacturing to the United States. Policymakers, such as Treasury Secretary Scott Bessent, are talking about a “great economic restructuring,” leading analysts to speculate on possible international agreements to secure investments and bring down the value of the dollar, as was successfully achieved during the Reagan Administration in the 1980s.

The strength of the U.S. dollar is a problem for a government determined to bring back the mercantilist policies of the late 19th century in America. As the chart below shows, the Real Effective Exchange Rate (REER) for the USD is at an extraordinarily high level, well beyond previous peaks in 1960, 1970, 1984, and 2002.

Periods of dollar weakness are associated with strong international growth relative to U.S. growth and a spell of “American malaise,” while periods of dollar strength are linked to stronger U.S. growth and phases of “American exceptionalism.” The dollar has been appreciating since early 2011 in a remarkable occurrence of American exceptionalism, driven by a relatively strong recovery from the Great Financial Crisis, the shale oil and gas revolution, and the phenomenal success of America’s tech titans. Over the past decade, the dollar has also been buttressed by enormous capital flows into U.S. assets, which originate both from institutional investors seeking high returns and from capital flight from emerging markets.

It is unclear how dollar weakness could be engineered by the Trump Administration, as “America First” strategies would tend to favor U.S. growth at the expense of foreign partners and could lead to large investment inflows. Moreover, the chaos created by Trump’s disruptive nature may increase geopolitical risk and further encourage capital flight into U.S. assets.

We can speculate on which countries may be targeted by Trump for retributive attacks. The chart below shows the REERs of America’s main trading partners and emerging markets in terms of the current REER relative to the median of the past 32 years. Japan stands out as an outlier and as an easy target for forced currency appreciation. Europe, Mexico, and the Asian tigers (Korea, Taiwan, and Malaysia) also could be singled out. The circumstances of most emerging markets (Chile, Brazil, Nigeria, etc.) are very different, as currency weakness is not engineered to sustain export competitiveness but rather caused by low growth and capital flight.