The Asymmetry of Global Finance
The conventional framing of global economic power tends to focus on trade balances and manufacturing output. This perspective misses a more consequential asymmetry: the world's financial architecture remains fundamentally dependent on the United States as the consumer of last resort.
Consider a counterfactual: if the United States were removed from the global economy, manufacturing capacity from Tokyo to Shanghai to Stuttgart would sit idle. The reverse does not hold. Germany has experienced three consecutive years of economic contraction (2022–2025), representing what the Handelsblatt Research Institute has described as the country's "greatest crisis in post-war history." China's property sector has contracted significantly. Yet the U.S. economy has continued to expand. A recession in China or Germany does not cause the United States to flinch; a modest U.S. slowdown, however, reverberates globally.
This asymmetry has profound implications for currencies, sovereign debt, and the emerging rotation from paper claims to real assets.
Japan's Consolidated Balance Sheet: The Hedge Fund State
For three decades, the "widow-maker" trade of shorting Japanese Government Bonds (JGBs) was predicated on a single metric: a gross debt-to-GDP ratio exceeding 260%. In conventional economic theory, such leverage should precipitate sovereign default or currency collapse. Yet yields remained pinned near zero, and the system held.
The failure of the bearish consensus stems from a fundamental accounting error: analyzing a nation's liabilities without assessing its assets. Japan is no longer the export-driven manufacturing hub of the 1980s. It has evolved into what can best be described as a leveraged investment vehicle—a sovereign hedge fund operating on a global scale.
Net Versus Gross Debt
To accurately assess Japan's solvency, one must look past the headline gross debt figure of roughly ¥1,017 trillion ($10.2 trillion, approximately 230% of GDP). The Japanese government possesses a substantial portfolio of financial assets, including cash, securities, and loans. When these assets are subtracted, the net debt-to-GDP ratio falls to approximately 128%.
The picture improves further when viewing the "consolidated government" balance sheet, which merges the Ministry of Finance with the Bank of Japan (BoJ). Because the BoJ holds more than 50% of outstanding JGBs, the state effectively owes half its debt to itself. When netting out BoJ holdings and foreign reserves, the debt held by the private sector is estimated between 77% and 115% of GDP—levels comparable to, and perhaps healthier than, the United States.
Unlike other highly indebted nations, Japan borrows not merely to fund consumption or social spending, but to accumulate income-generating assets.
From Trade Surplus to Investment Income
In the 1980s, Japan's economic power derived from a trade surplus—exporting physical goods. Today, the country often runs a trade deficit, exacerbated by the need to import energy and food. Yet its Current Account remains in substantial surplus ($193 billion in 2024).
This surplus is driven by the Primary Income Account. Japan has successfully transitioned from earning labor income to earning capital income. In 2024, the nation recorded a record ¥40 trillion in earnings from overseas assets. The Government Pension Investment Fund (GPIF), with $1.8 trillion in assets under management, exemplifies this shift. No longer a passive holder of domestic bonds, the GPIF has adopted an asset allocation resembling a university endowment, with a target allocation of 50% equities split between domestic and foreign holdings.
By borrowing Yen at near-zero rates domestically and investing in U.S. Treasuries and global equities yielding significantly more, Japan captures a substantial carry trade spread (A carry trade is an investment strategy that involves borrowing money in a low-interest-rate currency and investing it in a higher-yielding currency or asset, aiming to profit from the difference in interest rates).
The Central Bank as Equity Holder
Japan's transformation extends to its central bank. Unlike the Federal Reserve or the ECB, which primarily hold sovereign debt and mortgage-backed securities, the BoJ has accumulated an ¥83 trillion ($534 billion) portfolio of Exchange Traded Funds. The BoJ is now a top-10 shareholder in roughly half of all listed Japanese companies. As of late 2025, the central bank held unrealized gains of approximately ¥46 trillion ($300 billion).
This equity buffer creates a unique solvency loop: rising equity markets strengthen the government's consolidated balance sheet, providing a fiscal backstop unavailable to other G7 nations.
The U.S.-Japan Nexus: Managing the Symbiosis
The return of inflation has introduced volatility to the U.S.-Japan financial mechanism. Because Japan imports 90% of its energy—priced in dollars—an excessively weak Yen imports inflation. If the Yen depreciates beyond sustainable levels (as when USD/JPY approached 160), Japan faces pressure to defend the currency by selling U.S. Treasuries.
This presents a risk to Washington: if the world's largest creditor sells bonds to defend its currency, U.S. yields could spike, threatening domestic financial stability.
Consequently, U.S. policy appears to be shifting. The decades-old "Strong Dollar" mantra is giving way to implicit tolerance for a managed decline—or at least a stronger Yen—to prevent a disorderly liquidation of Japan's Treasury holdings. Effectively keeping yields lower in the U.S.
The Creditor Nation Paradox: Inflation as the Price of Surplus
The financial architecture that enables Japan's model creates an uncomfortable dynamic for all creditor nations. When the dominant consumer economy (the United States) runs persistent deficits, the creditor nations that finance those deficits ultimately absorb the consequences through inflation and currency debasement.
The Vendor Financing Mechanism
The relationship between the U.S. and its major trading partners operates as "vendor financing":
The Trade: The U.S. purchases goods and services; creditor nations (Japan, China, Germany, Korea) receive dollars.
The Recycle: Rather than repatriating these dollars (which would strengthen their currencies and hurt exporters), creditor nations reinvest them into U.S. Treasuries. Japan alone holds over $1.1 trillion in Treasury securities.
The Suppression: This demand suppresses U.S. yields, facilitating continued American borrowing and consumption.
The critical insight is that every major exporting economy has structured its currency policy to remain competitive against the dollar. The Yuan is managed to support exports. The Yen has been deliberately weakened. The Euro, despite the ECB's official neutrality, responds to currency appreciation as a policy concern.
This was illustrated in late January 2026 when ECB policymaker François Villeroy de Galhau explicitly stated that the euro's appreciation "is one of the factors that will guide our monetary policy stance and interest-rate decisions in the months ahead." A 2% gain in the euro prompted central bank commentary about policy adjustment.
The Race to the Bottom, Not the Top
When the United States signals preference for a weaker dollar—as evidenced by the 11% decline in the dollar index during the first half of 2025, the largest drop since 1973—creditor nations face a dilemma. If they allow their currencies to appreciate, their export sectors suffer. If they devalue in tandem, the result is competitive devaluation: a race to the bottom rather than the top.
Historical precedent suggests where this leads. During the Great Depression, over 70 countries engaged in competitive devaluations, contributing to a 25% decline in global trade volume. The 2010s saw similar tensions, with Brazil's finance minister coining the term "currency war."
The difference today is the scale of accumulated debt. When all major economies simultaneously seek weaker currencies, the question becomes: weaker against what?
The Post-2008 Precedent
The period following the 2008 financial crisis offers an instructive, if imperfect, parallel.
In November 2008, the Federal Reserve launched QE1, ultimately purchasing $1.75 trillion in mortgage-backed securities, agency debt, and Treasury notes by March 2010. QE2 followed in November 2010, adding another $600 billion in Treasury purchases. The Fed's balance sheet expanded from $891 billion (6% of GDP) in 2007 to $4.5 trillion (25% of GDP) by 2015.
The immediate effect on currency markets was dollar depreciation. Research from the Federal Reserve Bank of New York confirms that as the Fed engaged in quantitative easing, the dollar weakened—consistent with theoretical models showing that QE reduces bond and currency risk premia. The dollar depreciated approximately 7% in 2009 as the initial crisis panic subsided and Fed balance sheet expansion took hold.
The euro, by contrast, appreciated. The ECB was slower to act, initially refusing to engage in outright quantitative easing. This asymmetry—aggressive Fed easing versus ECB restraint—pushed EUR/USD higher through 2009 and into early 2010.
Then came the reckoning.
In late 2009, Greece's newly elected government revealed that its budget deficit would exceed 12% of GDP—nearly double previous estimates, later revised upward to 15.4%. Credit rating agencies downgraded Greek sovereign debt to junk status by early 2010. The contagion spread rapidly: Ireland required an €85 billion bailout in November 2010; Portugal followed with €78 billion in May 2011. Spain and Italy came under pressure. The euro plunged—from nearly $1.50 in late 2009 to below $1.20 by mid-2010, and again to multi-year lows against the dollar by March 2015.
The sequence matters: U.S. monetary expansion initially weakened the dollar and strengthened the euro, but the stronger euro exposed structural weaknesses in Europe's periphery. The PIIGS (Portugal, Ireland, Italy, Greece, Spain) could not devalue their way to competitiveness within a currency union, and the combination of recession and austerity produced a debt spiral that ultimately required ECB intervention through the Securities Market Programme and Mario Draghi's famous "whatever it takes" commitment in 2012.
The United States, meanwhile, recovered. By 2015, U.S. GDP had returned to pre-crisis levels, unemployment had fallen from 10% to 5%, and the Fed was preparing to raise rates. Europe remained mired in stagnation, with unemployment above 10% across the eurozone and deflation threatening.
Europe's Structural Constraints: Zero Fiscal Space
The European case illustrates the predicament of creditor nations without the institutional flexibility of Japan.
The Competitiveness Crisis
Europe's productivity growth has declined by approximately two-thirds over the past quarter century, from an average of 1.5% annually between 1999 and 2008 to below 0.4% in 2024. By 2023, Europe's productivity lagged behind the United States by 33 percentage points.
The continent's manufacturing sector faces structural headwinds. According to the Draghi Report on European competitiveness, around half of European companies cite energy costs as a significant barrier to investment—30% more than their U.S. counterparts. The European Central Bank reports that China competes with euro area exporters in nearly 40% of sectors, up from 25% in 2002.
Manufacturing value added per worker in the United States reached over $141,000 in recent years, exceeding second-ranked South Korea by over $44,000 and China by more than $120,000. Europe's industry has increasingly focused on twentieth-century demand categories rather than the high-value technology sectors driving U.S. and Swiss output.
The Fiscal Trap
Several major European economies face what can only be described as zero fiscal space:
France: Government debt at 118% of GDP, under excessive deficit procedure with a target to reach compliance by 2029.
Italy: Debt at 137% of GDP, the highest among major eurozone economies. Under excessive deficit procedure with consolidation targets through 2026.
Belgium: Debt at 102% of GDP, under excessive deficit procedure requiring net expenditure growth not to exceed 2.1% by 2029.
The IMF's October 2025 analysis projects that under current policies, average European debt ratios would reach 130% by 2040. The required deficit reduction to stabilize debt would be approximately 1% of GDP per year for five years—a cumulative 5% of GDP that "far exceeds what past European consolidation efforts have achieved."
As the IMF's Alfred Kammer stated in November 2025: "Unless Europe acts decisively to lift growth to a higher level, traditional fiscal consolidation measures will not be enough to prevent debt levels from becoming explosive."
The only exit for highly indebted European nations without growth is to ease the debt burden through inflation. But this creates its own trap: higher inflation means higher yields, which increases debt service costs, particularly for countries like Italy that issue debt at rates exceeding nominal GDP growth.
Germany has historically served as the anchor preventing this dynamic from destabilizing the eurozone. But Germany itself is now entering a cycle of recurring deficits, with government spending projected to push the deficit from 2.7% in 2024 to 4.0% in 2026. A potential sovereign debt crisis in Europe is a risk investors prefer to avoid all together.
The Dollar as the Only Gateway to Returns
The structural weaknesses of Europe and the managed nature of Asian currencies create a peculiar investment reality: for global investors seeking exposure to growth and innovation, the United States remains effectively the only option—and that means holding dollars.
The Composition of Global Equity Returns
The U.S. equity market now represents approximately 70% of global market capitalization in developed markets. More importantly, it contains virtually all of the technology and energy platforms that have driven returns over the past decade.
European corporations, by contrast, have increasingly become quasi-governmental entities. Regulatory compliance, stakeholder mandates, and industrial policy directives mean that many European firms now optimize for political objectives rather than shareholder returns. The distinction matters: U.S. technology companies serve consumer demand, government contracts, and industrial clients simultaneously, maintaining market discipline. Europeans increasingly answer to government (and export) demand alone, insulated from competitive pressure but also from the incentives that drive innovation.
An investor in Munich or Geneva who wants exposure to artificial intelligence, cloud computing, or the platforms reshaping commerce has limited options. European alternatives either do not exist at sufficient scale or operate under regulatory frameworks that constrain growth. The investment must flow to the United States.
The Hedging Trap
The obvious response for a non-dollar investor concerned about currency risk would be to hedge. A Swiss investor, for instance, might purchase U.S. equities while hedging the dollar exposure back to Swiss francs.
This strategy fails on inspection.
The interest rate differential between the United States and Switzerland currently runs approximately 4% annually. To hedge dollar exposure, the Swiss investor must pay this differential—effectively surrendering 4% of returns each year to currency hedging costs. Over a decade, this compounds to a substantial drag on performance.
The arithmetic is unforgiving. If U.S. equities return 8% annually in dollar terms, the hedged return in Swiss francs falls to approximately 4%. The hedge does not eliminate risk; it merely substitutes currency risk for the certainty of reduced returns.
For European investors, the calculus is somewhat less punitive given smaller rate differentials, but the direction is the same. Hedging costs money. And in an environment where equity returns are uncertain, paying a guaranteed annual fee to avoid currency exposure often makes little sense—particularly when the alternative currencies (Euro, Yen) face their own debasement pressures.
The Implicit Dollar Bet
The result is that global investors seeking returns are making an implicit—and often unhedged—bet on the dollar. This is not necessarily irrational. The same factors that make U.S. equities attractive (innovation, scale, market discipline) also support the currency. A strong technology sector generates export revenues. Profitable companies repatriate earnings. Foreign direct investment flows toward opportunity.
But it does create a concentration of risk. Global portfolios are now heavily exposed to both U.S. equity valuations and dollar strength. A scenario in which both reverse simultaneously—perhaps triggered by fiscal concerns or a loss of confidence in U.S. institutions—would produce losses with limited hedges in place.
The uncomfortable truth is that investors face a choice between accepting dollar exposure or accepting lower returns. For pension funds with long-term obligations, endowments with spending requirements, and individuals saving for retirement, the mathematics typically favor accepting the currency risk.
This dynamic reinforces the dollar's centrality even as central banks diversify reserves into gold. Private capital flows toward the United States because that is where the returns are. Official reserves rotate toward gold because that is where the safety is. The two movements are not contradictory; they reflect different objectives operating on different time horizons.
The Dollar's Foundations
Discussions of currency competition often focus on trade balances, interest rate differentials, and central bank reserves. These metrics matter, but they miss the deeper foundations of reserve currency status: military power and institutional credibility.
The United States maintains the most formidable military apparatus on the planet. Defense spending exceeds $850 billion annually—more than the next ten countries combined. The U.S. Navy operates eleven aircraft carrier strike groups; no other nation operates more than two. American military bases span the globe, from Okinawa to Ramstein to Diego Garcia. This is not merely about projecting power; it is about underwriting the global trading system itself.
When ships transit the Strait of Hormuz, the Strait of Malacca, or the South China Sea, they do so under an implicit American security guarantee. The dollar's role in pricing oil—the so-called petrodollar system—rests not just on historical convention but on the physical reality that American naval power secures the sea lanes through which that oil flows. A currency's value ultimately depends on the capacity of its issuing authority to enforce contracts and maintain order. The United States can do this globally; no other nation comes close.
The second pillar is institutional transparency. American financial markets operate under a legal framework that, whatever its flaws, provides predictable rules, independent courts, and enforceable property rights. The Federal Reserve publishes detailed minutes of its meetings. Corporate financial statements follow standardized accounting rules subject to audit. Government debt issuance follows regular, predictable schedules with full disclosure of terms.
The Chinese yuan offers neither of these foundations. China's military, while growing, remains primarily a regional force. Its navy has expanded rapidly but lacks the global reach, operational experience, and alliance networks that define American power projection. More critically, China's legal and financial systems remain opaque by design. Capital controls restrict currency convertibility. Corporate governance follows party directives as much as shareholder interests. The People's Bank of China does not operate with anything resembling Fed transparency. Foreign investors holding yuan-denominated assets have discovered, repeatedly, that the rules can change without warning when political imperatives demand it.
The euro presents a different problem: it is a currency without a state. The eurozone has no unified fiscal authority, no common treasury, and no joint military. The ECB conducts monetary policy, but fiscal policy remains fragmented across nineteen sovereign governments with divergent interests. When crisis strikes, decision-making requires unanimous agreement among nations whose electorates often have conflicting priorities. The 2010-2012 debt crisis demonstrated how slowly and painfully this process unfolds.
More fundamentally, the euro lacks a security dimension entirely. European defense depends on NATO, which in practice means American security guarantees. Europe cannot independently secure its energy supplies, its trade routes, or its borders. The Russian invasion of Ukraine in 2022 made this dependence starkly visible: European nations scrambled to diversify away from Russian gas while relying on American military aid to support Ukraine's defense. A currency backed by borrowed security is not a substitute for a currency backed by indigenous military power.
This asymmetry explains why, despite all the talk of de-dollarization, the dollar's share of global reserves has declined only modestly—from roughly 70% in 2000 to approximately 58% today. The yuan's share has risen, but remains below 3%. The euro has fluctuated around 20% for two decades without breaking higher. Reserve managers understand what academic economists sometimes forget: a reserve currency must be backed by more than monetary policy. It requires the capacity to project power and the willingness to enforce rules. Only the dollar offers both.
The Shift to Real Assets: Gold's Inelastic Supply
While the U.S. and its allies manage their bilateral exposures, a broader structural trend has emerged among global reserve managers: the rotation from sovereign debt to gold.
De-Fiatization, Not De-Dollarization
Despite narratives regarding the rise of a BRICS currency or the Yuan, the U.S. Dollar's role as a transactional currency remains unchallenged. However, as a store of value, sovereign debt is losing its premium status.
In 2024–2025, for the first time in roughly three decades, central banks held more gold than U.S. Treasuries as a percentage of their reserves. Gold now represents approximately 27–28% of global central bank reserves, while U.S. Treasury holdings have fallen to roughly 23–24%—a reversal of the pattern that prevailed since the mid-1990s.
Central banks have accumulated over 1,000 tonnes of gold annually for three consecutive years since 2022, roughly double the decade-long average. The World Gold Council reports that 76% of central banks expect to increase their gold holdings over the next five years, while 73% expect their dollar reserves to decline.
This is not "de-dollarization" in the sense of currency substitution—the Euro and Yuan are not gaining reserve share. Rather, it is "de-fiatization." Reserve managers are reacting to the simultaneous deterioration of balance sheets at major central banks (including the Fed and ECB) and the geopolitical weaponization of the financial system.
The Supply Inelasticity Argument
Gold possesses a characteristic that distinguishes it from most commodities: profoundly inelastic supply. As J.P. Morgan Research noted, "gold mine supply [is] relatively inelastic and slow to respond to higher prices." It takes years to bring new gold mines online, and current production cannot keep pace with demand surges.
This inelasticity creates a price dynamic where small changes in demand translate into outsized price movements. When central banks, which typically hold positions long-term, increase their purchases, they create structural demand that cannot be met by increased supply. Conversely, if selling were to accelerate, the same inelasticity would work in reverse, amplifying downward price pressure.
Gold prices surged over 55% in 2025, surpassing $4,000 and then $5,000 per ounce for the first time. J.P. Morgan forecasts prices pushing toward $6,000.
The Real Return Calculation
The investment case for gold over Treasuries rests on a straightforward calculation. When debt debasement runs at approximately 4% annually (through fiscal deficits monetized directly or indirectly), a nominal Treasury yield of 4% delivers zero real return—and potentially negative real returns after accounting for the erosion of principal value.
Gold yields nothing in nominal terms. But if its price rises with inflation—or faster, due to the supply-demand imbalance—it preserves purchasing power where Treasuries do not.
Central banks, as the most risk-averse financial managers, have evidently concluded that sovereign debt now represents "return-free risk" rather than "risk-free return." Their collective action—voting with their reserves—constitutes the most significant global portfolio rebalancing in modern financial history.
Still, one should note that gold is a terrible reserve asset for immediate liquidity. You cannot press a button and collateralize 1,000 tonnes of gold to settle a margin call in seconds the way you can with US Treasuries. If a true liquidity crisis hits, Central Banks might be forced to sell gold to get Dollars (the only liquid asset that matters), causing gold prices to crash exactly when they are needed most.
A Bifurcated Monetary Order
The global financial system is not transitioning from American hegemony to Chinese hegemony. Instead, it is bifurcating by function:
The U.S. Dollar remains the operating system of global commerce—the medium of exchange. Trade invoicing, SWIFT transactions, and cross-border payments continue to flow through dollar infrastructure.
Gold is re-emerging as the ultimate reserve asset—the store of value for nations seeking to hedge against both inflation and geopolitical risk.
For Japan, maintaining the "hedge fund" model requires careful management of the Yen to protect its energy security and avoid importing excessive inflation.
For the United States, it necessitates tolerance for a weaker dollar to keep debt serviceable without triggering disorderly selling by its largest creditors.
For Europe, the structural constraints of low growth, high debt, and limited fiscal space create pressure toward inflation-financed adjustment—with attendant risks to sovereign creditworthiness.
For the rest of the world, the strategy is increasingly clear: owning the debt of developed nations carries risks that gold does not. The rotation from paper claims to real assets appears structural rather than cyclical.
Absorbing Inflation
The dynamics described above do not point toward imminent collapse. Japan's balance sheet remains manageable precisely because of its consolidated asset position. The U.S. retains fiscal space unavailable to its European counterparts. Gold's price reflects rational portfolio diversification rather than flight.
But the trend lines are unmistakable. Creditor nations financing U.S. consumption will ultimately absorb costs through currency depreciation or inflation. Competitive devaluation favors no one sustainably. And the world's central banks have begun positioning for a monetary order where the asset class free of counterparty risk—gold—commands an increasing share of reserves.
Disclaimer
Please note that Benchmark does not produce investment advice in any form. Our articles are not research reports and are not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.
Credits
Photo by John McArthur / Unsplash.
