�������

When President Donald Trump unveiled global tariffs on April 2, foreign investors responded by dumping U.S. debt and other dollar-denominated assets. What happened next in the bond and currency markets was unexpected and could signal long-term damage to the dollar’s role as the world’s reserve currency, according to new research by Stanford Graduate School of Business finance professors Arvind Krishnamurthy and Hanno Lustig.

Based on their models, the scholars — both senior fellows at the Stanford Institute for Economic Policy Research (SIEPR) — conclude that Trump’s tariffs may have pushed investors to question the dollar’s future. And they note that this skepticism could reflect less willingness to let the U.S. government to borrow cheaply in the future.

Typically, investors flock to dollar debt as a safe haven from financial uncertainty, boosting the currency’s value. Yet that’s not what happened following Trump’s tariff rollout and China’s retaliation two days later. Yields on Treasurys and investments in dollars suddenly increased. Based on this, the dollar should have appreciated by about 5 percent. Instead, its value fell by more than 3 percent over the next 10 days.

This surprising disconnect suggests that international investors are losing confidence in the safety of dollar-denominated assets, and the dollar itself, says Krishnamurthy. During previous periods of volatility, such as the financial crisis of 2007–2009 and the COVID pandemic, the market very consistently favored the dollar. “That’s the pattern we’ve seen in the past,” he says. “This pattern looks clearly different.” During the first 100 days of the Trump administration, the dollar’s value fell .

Lustig points to a usually unremarkable corner of the bond market as another indicator that a significant shift is underway. After April 4, the premiums investors pay for Treasury bonds quickly deteriorated in relation to the German bund, reaching levels of  not seen since at least 1989. “The willingness of foreign investors to pay a bit extra for Treasurys — that’s gone,” Lustig says.

For decades, investors have been eager to purchase U.S. debt, even if it meant earning lower yields. “The world wants to hold their wealth in a safe and liquid place, and the U.S. has been the provider of that,” says Krishnamurthy. Krishnamurthy, Lustig, and their colleagues have found that at the height of the global financial crisis in 2008, European investors were willing to forgo about 1 percent in annual returns for the convenience of holding Treasurys, known as the “convenience yield.” But to quote the title of a new paper they released after the tariff announcement, “this time is different.”

Flight from unpredictability

In their paper, Krishnamurthy and Lustig document a profound change in investor sentiment following Trump’s “Liberation Day” announcement. With Zhengyang Jiang at the Northwestern University Kellogg School of Management, Robert Richmond at the New York University Stern School of Business, and Chenzi Xu at the University of California-Berkeley, they calculate that European investors suddenly required an additional 2.2 percent annual convenience yield for holding onto Treasurys.

Most U.S. Treasury debt is held by international investors, whose willingness to “buy America” is reflected in the dollar’s status as the world’s go-to currency for international trade, government debt, and central bank holdings. Yet that dominant position could be undermined by the recent capital flight away from the U.S. While Krishnamurthy and Lustig say that it is unlikely a spiral of “de-dollarization” will completely dethrone the dollar, currencies like the euro could rise in importance over the next decade.

This change in investors’ perception of the United States’ fiscal reliability reflects the unpredictability surrounding the on-again, off-again implementation of the Trump administration’s trade policy. “They’ve injected a ton of policy uncertainty into financial markets,” Lustig says.

However, there’s a certain logic behind the uncertainty. As Lustig explains, the administration’s economic team believes that the dollar is overvalued, making it hard for American industries to compete in foreign markets. The thinking goes that the U.S. must reengineer the international financial system so that the dollar falls, U.S. exports rise, and trade surpluses narrow as manufacturing jobs come back to the States.

Yet the administration appears to have underappreciated the complex interconnections between the economic variables it seeks to recalibrate. “You can’t say the U.S. is going to run current account surpluses from now on but we still want to borrow at lower rates than the Germans,” Lustig says. “That’s not quite how these things work.”

Over the last few decades a constellation of economic forces has enabled exceptional U.S. growth. Robust demand for Treasurys and U.S. assets meant lower interest rates and higher asset values across the board. That, in turn, led to a stronger dollar. “The administration is trying to have its cake and eat it too,” Krishnamurthy says. “They would like to reengineer the dollar to be depreciated, but would like the U.S. government to be able to continue to borrow at low rates. I’m not sure you can get both.”

On borrowed time

Lustig notes that the bond market’s growing wariness toward Treasurys is also based on the big picture of U.S. borrowing. For decades, the federal government has counted on foreigners to buy its debt through thick and thin. “That’s why we’ve been able to run big deficits in bad times, which other countries can’t really do to the same extent,” he says. “But it doesn’t look like that’s going to continue, because foreigners are just not rushing to the safety of Treasurys the way they were before the pandemic. If you’re the secretary of the Treasury Department, that should keep you up at night.”

Many economists expect the U.S. budget deficit to explode if Congress passes the huge tax and spending cuts currently under discussion. This, combined with the prospect of a tariff-induced recession, is fueling concerns that the U.S. will not meet its future obligations. Trump’s threats to fire Federal Reserve Chairman Jerome Powell have further rattled confidence.

The experience of the United Kingdom under Prime Minister Liz Truss in 2022 comes to mind, Lustig says. Investors rejected the short-lived Truss government’s enormous tax cuts by driving up bond yields. Former Treasury secretary Larry Summers  that the British pound was trading like it belonged to an “emerging market, turning itself into a submerging market.” (Summers  that “U.S. assets are trading more like those of an emerging market nation than those of a nation with the world’s reserve currency.”)

The unraveling of the bond market quickly caught the attention of some in Washington. “One could argue that the U.S. Treasury market vetoed the tariff plan that this administration was rolling out,” Lustig says. “There’s at least some evidence that the dramatic increase in yields caused some people in the administration to pause some tariffs.”

While bond vigilantes may have tempered the tariffs’ initial impacts, they have yet to reverse the overall trend that Krishnamurthy, Lustig, and their colleagues have observed. “I don’t think the world is done with the dollar,” Krishnamurthy says. “I don’t feel like that’s the world we’re in right now. But I think investors are definitely questioning the dollar.”

A version of this story was May 5, 2025 by Stanford Graduate School of Business Insights.