The modern international monetary system is built on a structural asymmetry that has persisted for decades: the United States runs large and continuous current-account deficits, while high-saving economies such as China, Japan, and Germany run persistent surpluses. It is not the result of mercantilist policy choices or short-term political decisions but the outcome of deep structural forces: demographic profiles, institutional design, financial-market development, and the fundamental macroeconomic identity linking savings, investment, and the current account. The concepts are deceptively easy to
understand.
For instance, in China, the one-child policy has led to an ageing population, contributing to high household savings due to less social security. Japan is facing similar demographic trends with a rapidly ageing population, with high savings and fewer domestic investment opportunities. Germany, with its strong export-oriented economic structure and historical aversion to inflation, maintains high savings and global competitiveness. These trends illustrate how societal forces shape economic behaviours in these countries.
Understanding this system requires tracing the connections between global savings imbalances, foreign holdings of US debt, the role of the dollar, and the institutional architecture of the Federal Reserve and the US Treasury. It also requires examining what would happen if these relationships were disrupted, whether through political interference in US monetary policy or through China opening its capital markets to challenge the dollar’s dominance.
Let’s start with the simple identity that lies at the centre of global current account imbalances: a country’s current account balance = its domestic Savings minus domestic Investment.
The identity says that a country that saves more than it invests must export the surplus savings abroad, and a country that invests more than it saves must import foreign savings. (That all assumes it’s an open economy, i.e., one that trades with the rest of the world). This identity explains why some countries run persistent trade surpluses, and others run persistent deficits.
The chart below shows how the foreign, government and private balances always move together — summing to zero each year. The US consistently runs a foreign deficit and a private surplus, with the government deficit adjusting to balance the system. Recessions trigger spikes in private saving and deeper government borrowing, while the foreign deficit remains structurally persistent.
Attempts to eliminate these imbalances through tariffs, currency intervention, or industrial policy often fail in the longer term: the underlying savings–investment gap reasserts itself after short-term shocks.
For example, historical attempts such as the imposition of US tariffs on Chinese goods have not successfully addressed the underlying economic imbalances. While they temporarily affected trade flows, the deeper structural issues, driven by the savings-investment dynamics, remained largely unchanged.
High Saving big countries
High-saving countries such as China, Japan, and Germany exhibit structural features that generate excess savings. In Japan, an ageing population, high household savings, and limited domestic investment opportunities create a surplus of capital that must be invested abroad. In China, high ‘precautionary’ savings, weak social safety nets, capital controls, and a managed exchange rate combine to produce a large pool of excess savings. Germany’s surplus reflects a combination of demographic ageing, strong manufacturing
competitiveness, and a cultural preference for saving rooted in its experience of hyperinflation in the past.
These forces are not easily altered by policy, as they are embedded in each country’s economic and social fabric. The result is a persistent current-account surplus. And because the current account and the capital account must sum to zero, these surpluses necessarily generate capital outflows. The savings must go somewhere.
Here is the schematic:
High household savings + Limited domestic investment = Excess national savings, which must be invested abroad = Capital outflow = Trade surplus (by identity).
This is why it is misleading to view China’s or Japan’s surpluses as ‘purely’ deliberate policy acts. This is not to say that these outcomes aren’t seen as politically desirable, but that policy could not lead to them without that underlying structural position between savings and investment. They are the macroeconomic consequences of structural imbalances between savings and investment.
Meanwhile, the US is a net borrower
The United States sits on the other side of this equation. It saves less than it invests and therefore must import foreign savings. Several factors contribute to this. The US has deep, innovative capital markets, strong investment demand, and a global role that requires supplying safe, liquid assets to overseas savers seeking returns on their excess savings. The US current-account deficit is therefore not just a sign of “living beyond its means” –
though it is. But it is also the mechanism through which the world obtains the dollar liquidity it demands.
| 1. Japan $1.18 trillion
2. United Kingdom $723 billion 3. China $700 billion 4. Canada $472 billion 5. Luxembourg $340 billion 6. Ireland $320 billion 7. Switzerland $290 billion 8. Belgium $280 billion 9. Taiwan $260 billion 10. Brazil $250 billion |
Table 1: Top ten holders of US debt, 2025 (Source: US Treasury)
Here’s how it works:
1. The US imports are greater than its exports, so it has trade deficits.
2. Foreign exporters accumulate dollars.
3. They invest those dollars in US Treasuries.
4. The US receives foreign savings, so it has a capital-account surplus.
5. This finances US fiscal deficits (its lack of internal savings to fund borrowing)
6. The world receives safe dollar assets…
7. …the cycle repeats.
This relationship explains why China and Japan hold so much US debt. Their excess savings must be invested somewhere, and the US Treasury market is the only market deep, liquid, and safe enough to absorb such volumes. Japan’s motivations are rooted in demographics and low domestic returns. China’s motivations stem from its managed exchange rate, export-led growth model, and the need to recycle export earnings into safe assets. In both cases, the US Treasury market is the natural destination.
It also explains why the US can run large deficits without facing the currency crises that emerging markets experience. The world needs US Treasuries, and the US is the only country capable of supplying them at scale.
How much of a threat is there to US dollar dominance?
This raises an important question: what would happen if China or Japan stopped buying US debt, or even sold it? The popular fear is that the dollar would collapse. However, this misunderstands how global capital markets work. According to recent estimates, China holds approximately $1 trillion in US Treasuries, and Japan holds around $1.3 trillion. If they were to sell significant portions of these holdings, US Treasury yields would undoubtedly
rise, attracting private investors seeking higher returns.
Financial market reactions in past instances of large Treasury sell-offs have shown increased short-term volatility, but no immediate catastrophic effects on the dollar itself. Thus, while a sell-off could trigger temporary market adjustments, it is unlikely to lead to a complete collapse of the dollar. Instead, the increased yields would likely draw private global capital to fill the gap left by these nations.
The dollar might even strengthen in the short run as investors chase higher returns. Meanwhile, China and Japan would suffer currency appreciation, hurting their exporters. They would eventually return to Treasuries because the alternatives — the euro, yen, or renminbi — lack the depth, liquidity, and institutional credibility of the US market.
A more realistic scenario is that China and Japan simply stop adding to their holdings. In that case, US yields would rise, borrowing costs would increase, and the US economy would slow. Consumption and investment would fall, imports would decline, and the trade deficit would narrow. The system would rebalance through higher savings and lower consumption. Painful, yes — but not catastrophic. The dollar’s role would remain intact.
The distinction between the Federal Reserve and the US Treasury is crucial here. The Treasury spends money; the Fed sets interest rates. US debt is high because Congress runs large fiscal deficits, not because the Fed “spends.” However, if interest rates rise, the Treasury’s interest bill rises, creating fiscal pressure. This is where political risk comes into play.
Imagine a scenario in which the Treasury Secretary is appointed explicitly to keep borrowing costs low, and political pressure is applied to influence monetary policy. This could trigger a fiscal firestorm that would be hard to put out.
Scenario: political pressure to keep rates low rises.
According to the U.S. Department of the Treasury, Secretary Scott Bessent recently said that the US Treasury market is more robust and more liquid than it’s ever been, contradicting claims of an uncontrolled, unusual monetisation of Treasuries by some observers. Yet the US has institutional firewalls: the Fed’s independence is legally protected, the Treasury cannot set interest rates, markets punish manipulation, and courts and Congress constrain political interference. Political pressure can create volatility, but in theory it should not be able override the system.
The final hypothetical is the most strategically significant: what if China opened its capital markets to compete with the dollar?
For the renminbi to become a true rival, China would need to make it fully convertible, allow free capital flows, build deep and transparent bond markets, guarantee the rule of law without favour, and allow foreign investors to enter and exit freely. But these steps would undermine the Party’s political control and expose China to destabilising capital flight. Even if China did open its markets, the dollar would remain dominant because of ‘network effects,’ institutional strength, and the unmatched depth of US financial markets
for many years.
This resilience of the dollar has a historical precedent in the British pound’s eventual replacement by the dollar. The transition occurred over several decades during the early to mid-20th century, driven by the economic rise of the United States and its emergence as a financial superpower, especially after World War I. The UK’s relative economic decline and the severe impact of World War II further accelerated this shift.
The significant global influence of US financial institutions, the establishment of the Federal Reserve System, and the dollar’s role in the Bretton Woods system cemented the dollar’s dominance over the pound. Understanding this transition helps illustrate the complexity and gradual nature of currency shifts on the global stage.
The global dollar system is therefore more resilient than many assume. It is built on structural imbalances that reflect big differences in savings behaviour, financial development, and institutional strength.
China and Japan hold large amounts of US debt because they generate excess savings and need safe assets. The US runs deficits because the world demands dollar liquidity. If foreign demand falls, the system adjusts through higher yields and slower growth, not collapse. If the Treasury becomes politicised, inflation risks rise, but institutional firewalls limit the damage. If China opens its markets, it gains influence but undermines its own growth model.
Conclusion
The dollar’s dominance can bend under stress, but the alternatives are too weak, too small, or too politically constrained to replace it, at least for now. Of course, its dominance is not guaranteed forever, but there are few countries with the necessary attributes and willingness to become the international currency of choice. However, some countries or blocs could potentially challenge this dominance in the future.
For instance, the Eurozone, with its economic size and advanced financial markets, could increase its influence if it achieves greater political and fiscal integration. Similarly, if China successfully implements financial reforms to enhance the renminbi’s convertibility and transparency, it might position itself as a contender. These potential challengers would need to build robust, liquid, and transparent markets and ensure political and economic stability to effectively contest the dollar’s role. That day is therefore well into the future, but it doesn’t mean that the dollar won’t experience severe bouts of volatility as events unfold.