Tim Sablik sets the stage for the conversation in “Carmen Reinhart: On twin financial and currency crises, the future of the dollar, and sovereign debt” (Econ Focus: Federal Reserve Bank of Richmond, Third Quarter 2025).
On the status of the US dollar as the global reserve currency:
When we talk about the dollar’s dominance, it’s important to first remember that central banks and investors are not buying greenbacks, they’re buying Treasuries. And it is the unmatched liquidity of the Treasury market that supports the role of the dollar. … When the euro came into being, for a while it looked like, while it might not replace the dollar, you could have a situation with dual reserve currencies. Before the global financial crisis, investors tended to view all European debt — whether it was French debt, German debt, Greek debt, or Irish debt — as close substitutes. Of course, the global financial crisis completely destroyed that perception. What it boils down to is that you have very fragmented debt markets in the eurozone that don’t offer the liquidity of the U.S. Treasury market. The euro is a unified currency, but there is no unification of the underlying assets that support the currency. Others have argued that the Chinese renminbi could be a contender to replace the dollar. I’ve never really entertained that possibility because, as Rudi Dornbusch used to say, people only go to a party if they think they can leave whenever they want to. China has capital controls, which directly impacts the liquidity of their debt market. How could you have as a reserve currency an underlying asset that in a time of need you can’t sell?
On the challenges of high US government debt levels:
The recent surge in U.S. debt has outpaced many other advanced economies. Since the end of the pandemic, we’ve had ample opportunity — with a very tight labor market — to deliver more balanced budgets that would not continue to add to our debt, but we haven’t done so. Am I worried? Yes. Debt servicing has become more costly. Additionally, in the recent past when inflation and interest rates were low for long, volatility was suppressed. Now we have a combination that is much more difficult to manage: very high levels of debt, higher interest rates, and higher volatility.
The issue that I’ve always highlighted in my work is that there’s no silver bullet for dealing with high levels of public debt. Many countries might wish they could grow out of their debt, but that’s aspirational. Japan has been aspiring to grow out of its debt for decades. This is complicated by the fact that, as we discussed, growth is slower in periods of high debt burdens. That finding is based on long historic averages. If you look at Greece’s recovery from the global financial crisis, their per capita income in recent years was still below what it was before the crisis. So, there are no easy ways of delivering debt reduction. Growing out of the debt is unlikely if growth is slowing. Fiscal tightening is difficult. Inflation as a means of debt reduction is very unappealing. Debt restructuring, which is another term for defaulting, is also very unappealing.
On the social costs of a country defaulting on its debt:
The social costs of default have been overlooked in the economics literature. Typically, when one thinks of all the costs of default, there are the political costs, the fear of retaliation in terms of getting shut out of capital markets, and the economic costs. But related to those economic costs, you could think about the costs for households in terms of nutrition or health outcomes, for instance. And the research on those costs was a blank sheet. So, I wrote a paper with Juan Farah-Yacoub and Clemens Graf von Luckner, former students of mine, trying to quantify those costs. The results are pretty striking in terms of direction and duration. Life expectancy compares poorly versus the non-defaulters, and there is some increase in infant mortality. But the biggest effect that we see, apart from per capita GDP, is on poverty measures and things like caloric intake. So, the human toll of sovereign default is significant and long-lasting.
