## Café Economics

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**Canonical URL:** [Café Economics](https://www.imf.org/-/media/files/publications/fandd/article/2025/12/cafe-economics.pdf)

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### Origins of dollar dominance
- Two world wars cemented the dollar's position: World War I weakened Britain, and after World War II the US had "perhaps 40 percent of global GDP" and became the dominant currency.
- Postwar agreement: many countries pegged their currencies to the dollar; the US was constrained by an obligation to "trade dollars for gold whenever official creditors asked" until 1971.
- Nixon's 1971 decision ended convertibility: "You know what we said about trading your dollars for gold? Not any more. We’re not going to do it."

### The post-1971 era and US policy stance
- After going off gold, the US lacked a plan to control inflation; Treasury Secretary John B. Connally's remark: "Well, it’s our dollar. That’s your problem."
- Rogoff on US policy risks:
  - Undermining the Federal Reserve’s independence.
  - Persistent deficits and rising debt pose threats to financial stability.
- Historical institutional context: Rogoff served as IMF chief economist in 2001–03 and notes long-term structural effects from the postwar period.

### Role of China and the dollar bloc
- China’s extended pegging to the dollar significantly expanded the dollar bloc: "Today, Asia is half the dollar bloc. It might have been more like a quarter or a third if China hadn’t been circling around the dollar for so long."
- Rogoff argues China’s fixed exchange rate "distorted their development" but also helped enlarge the dollar’s footprint.

### Competitors to the dollar and potential shifts
- Marginal competitors include "the euro, crypto, the renminbi"—all "chipping away at dollar dominance."
- Key risk: investors might find the dollar less desirable; to absorb increased dollar supply they "will demand a higher interest rate."
- Possible outcome: "The dollar could keep its number one position but lose market share."

### Debt, long-term interest rates, and risks to reserve status
- Rogoff identifies debt as "the biggest danger to the dollar’s strength" and challenges the notion that US debt is inherently safe.
- Observations on interest rates and fiscal exposure:
  - "Interest rates have risen."
  - Rogoff expects "long-term interest rates are going to stay high for a very long time, at least on average."
  - Example vulnerability: a "2 percent mortgage suddenly jumps to 7 percent."
  - "US bond yields haven’t jumped that much, but our interest payments have nearly tripled relative to GDP in a short period. They’re bigger than defense expenditure."
- Political economy: little current political will to "rein things in" on deficits; adjustments may be hard until a fiscal "cliff edge" is reached.
- Critique of prior complacency: many economists assumed persistently low rates (secular stagnation view) and that debt-service risk was minimal; Rogoff warned that if rates do not stay low, "debt service would soar."

### Central bank independence and policy implications
- Central bank independence is a major policy innovation, but faces pressures: "Central bank independence is under assault everywhere. It’s worried me before, but never more than now."
- Sources of pressure include populist demands for central banks to address the environment and inequality, and pandemic-era "mission creep."
- Rogoff warns against undermining independence and implies policy priorities should preserve credible monetary institutions.

### Historical episodes of currency competition
- The yen and Japan were once seen as potential challengers: Japan at one point had "half the population of the US" and its stock market and real estate "were worth more," but subsequent financial crisis curtailed that trajectory.
- The renminbi might have become more independent earlier, but China’s peg sustained dollar advantage.

### Scenarios and policy recommendations (implied by interview)
- Scenarios:
  - Continued high long-term interest rates lead to rising debt-service costs and fiscal stress.
  - Dollar retains number-one status but loses market share as investors demand higher yields.
  - Central bank independence erodes, raising inflation and credibility risks.
- Policy recommendations and priorities:
  - Preserve central bank independence to control inflation and maintain credibility.
  - Recognize and prepare for the likelihood of sustained higher long-term interest rates.
  - Undertake fiscal adjustments to address rising interest payments and large deficits before they reach a crisis point.

*F&D: Café Economics, DECEMBER 2025.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2025/12/cafe-economics.pdf_