[EAI Special Commentary] US Debt, Dollar Hegemony, and the Fracturing International Financial Order: Implications for Korea

I. US Federal Debt: Is It Sustainable?

We often view the US-China hegemonic competition as a zero-sum game where one side wins and the other loses. However, the financial order presents a different picture. The US cannot sustain its debt system without foreign capital inflows, and China cannot develop its own payment system without the infrastructure laid by the US and Europe. They are bound together, unable to fully replace or abandon each other. This mutual constraint defines today's international financial order.

Against this backdrop, the debate over the sustainability of US debt is fierce. The trigger is its astronomical scale. Total US federal debt surpassed $38 trillion in October 2025, reaching approximately 123% of its Gross Domestic Product (GDP). Even by the metric of publicly held debt, which markets closely watch, it rose to 99.8% of GDP by the end of fiscal year 2025. This is the highest level in history, excluding the immediate post-World War II period. The fact that debt ratios are approaching wartime levels during peacetime has ignited the debate.

However, what determines sustainability is not the size of the debt but the relationship between interest rates and growth rates. The comparison between the real interest rate (r) and the nominal growth rate (g) is crucial. If g is greater than r, growth naturally absorbs the debt. If r exceeds g, the debt grows on its own, even if the government does nothing. For nearly 60 years, the US has been in a safe zone where g has been greater than r. Currently, however, g is approximately 5.6% and r is approximately 4.6%, narrowing the gap to just 1 percentage point. This margin is rapidly disappearing as interest rates on newly issued Treasury bonds rise.

The consequence is a surge in interest expenses. Net interest payments for fiscal year 2025 are projected to be around 3.1% of GDP, nearing or already exceeding the previous peak of 3.2% in 1991. The critical difference is the direction: the peak in 1991 was a one-time event, whereas the current trend is continuously upward. The Congressional Budget Office (CBO) forecasts that net interest payments will reach 4.6% of GDP by 2036 and exceed 6% by the mid-2050s. At that point, approximately 40% of federal revenue would be used to service debt. The implication is clear: escalating interest costs represent a structural burden that no administration can easily reduce in the short term.

This fiscal crisis has not yet materialized due to the inflow of foreign capital. The US attracts about $1.2 trillion in foreign capital annually, and its net international investment position stood at approximately -$27.5 trillion by the end of 2025, comparable to its federal debt. The sole condition for the functioning of the US financial system is the continued inflow of this capital. The moment that flow abruptly stops or reverses, triggering what is commonly called a 'sudden stop,' a US-led financial crisis becomes inevitable. This is the very mechanism that South Korea experienced in 1997.

Therefore, the debate bifurcates. One side argues for preemptive measures to reduce debt and interest costs, while the other believes the status of a reserve currency country sustains the system without such interventions. However, this debate misses the point. The issue is not whether the US will go bankrupt. One of the most significant challenges facing the global economy over the next decade is not whether the US will go bankrupt, but whom the non-bankrupt US will shift the costs to.

II. Will the US Government Go Bankrupt?

It is virtually impossible for the US government to go bankrupt due to its debt. Concerns about debt are often expressed as fears of default, but this is a concern based on the wrong question. The reason is simple: the US is a reserve currency issuer capable of printing its own currency to repay its debts. Another option is for the Federal Reserve to purchase more Treasury bonds, effectively a shift towards fiscal dominance where monetary policy is dictated by fiscal policy. Entry into this path has already begun. The Fed ended its quantitative tightening, which had been ongoing since June 2022, in December 2025.

To understand the path forward for the Fed, Japan serves as a reference. The Bank of Japan holds over half of its country's government bonds, effectively transferring government debt onto the central bank's balance sheet. The Fed's current holdings of Treasury bonds are around 10%. Although this figure temporarily surged to over 20% during the COVID-19 crisis, it has been on a downward trend since then. Compared to Japan's path, there is still ample room. It is no exaggeration to say that US monetary policy over the next decade will depend on how quickly and to what extent the Fed purchases Treasury bonds. In short, bankruptcy is not an option.

However, the Fed's purchase of Treasury bonds does not eliminate the fiscal crisis. The crisis does not disappear but transforms its form, shifting the costs onto specific groups. The channels for this ultimately converge into one: the US eroding its debt burden through inflation, that is, gradually devaluing the real value of the dollar. This single process imposes burdens on three groups in different ways.

First, US citizens bear the burden through rising prices. When money is printed to buy debt, prices increase, reducing real wages and purchasing power, with a significant portion of this burden falling on the middle class.

Second, foreign holders bear the burden through the erosion of real value. Foreign governments and institutions currently hold about $9.5 trillion in US assets. As long as inflation persists, the nominal value of these assets and the nominal interest on Treasury bonds will be maintained, but their real value, excluding inflation, will be quietly diminished. The Bank of Korea holds about $360 billion, or 88-90% of its foreign exchange reserves, in US securities, making it directly exposed to this erosion. Losses occur without default or balance sheet write-downs. This is a silent loss.

Third, countries begin to lose confidence in the dollar system. Observing the US shifting its debt burden in this manner, central banks worldwide diversify their reserve assets to reduce dollar dependency and turn to alternative payment infrastructures. In the process of this transition, chaos in the international financial order is inevitable.

This triple burden-shifting aligns with the strategy of a potential second Trump administration. The goal is to lower the value of the dollar to boost export competitiveness and alleviate debt and interest burdens through inflation, with the costs ultimately passed on to foreign holders. While there is no nominal default, this risk is amplified by changes in the supply structure of the US Treasury market.

III. Why Has the Market Become Riskier?

If there is no bankruptcy, the real risk lies in who buys the Treasury bonds. The funding structure of the US Treasury market has quietly but fundamentally changed over the past decade. The proportion of US Treasury bonds held by foreign governments has fallen from about 50% in 2008 to about 30% currently. The privilege the US has long enjoyed, namely foreign official demand that formed independently of fiscal risk, is drying up.

Analyzing this decline reveals that three countries are acting for different reasons. Japan, with about $1.2 trillion, remains the largest holder, but it cannot sell if it wanted to. It holds so much that large-scale sales would cause its own assets to collapse. This is a form of forced participation. The UK's holdings increased more than fivefold, from $160 billion in 2013 to $863 billion, but this reflects the positions of global hedge funds and pension funds concentrated in London being statistically captured, rather than a deliberate decision by the UK government. China reduced its holdings from $1.32 trillion to $684 billion during the same period, a clear intentional move to exert pressure. Thus, the same asset is held by three countries for three different reasons.

What is truly important is who filled the void. The answer is hedge funds registered in the Cayman Islands. These funds purchased approximately 37% of newly issued US Treasury bonds between 2022 and 2024, and have now become the largest foreign holder, surpassing China, Japan, and the UK. As of the end of 2024, their holdings amounted to about $1.85 trillion, an increase of $1 trillion in two years.

These hedge funds currently hold about 8-10% of US Treasury bonds. This is a scale comparable to a single country's central bank, but with the opposite characteristics. Most of their bond holdings are purchased with borrowed funds; top funds leverage up to 18 times their own capital. The problem is that this structure is vulnerable to even minor shocks. If the market becomes unstable and bond prices fall even slightly, lenders demand more cash against the same bonds as collateral, valuing them lower. Funds operating on leverage are forced to sell their collateralized Treasury bonds to raise cash.

This is where the real risk begins. Since dozens of funds invest in nearly identical ways, a sell-off by one fund causes prices to fall further, which in turn reduces the collateral value for other funds, forcing them to sell as well. This creates a cascade of selling. This is precisely what happened in March 2020. Amid the COVID-19 shock, these investments unwound simultaneously, causing basis traders to dump about $100 billion worth of Treasury bonds, paralyzing the US Treasury market, considered the deepest in the world, for several days. Ultimately, the Fed had to intervene and purchase bonds.

Currently, this leverage has doubled compared to that period. Of course, not every shock leads to a crisis. During the turmoil caused by Trump's reciprocal tariffs in April 2025, the Fed's liquidity facilities operated, preventing major issues. However, the fact remains that this record-high leverage persists as a constant vulnerability in the market. The Treasury market, once considered the safest, could paradoxically become an amplifier of crises.

Despite this, the dollar system is unlikely to collapse easily. Paradoxically, the reason is the lack of alternatives. Money flowing out of the US market has few viable destinations. The Eurozone is constrained by structural stagnation and limitations in fiscal integration. Japan's financial market is small, and China has not fully liberalized its capital account, making it difficult for money that enters to exit.

Relatively speaking, the US market remains the deepest, most transparent, and most liquid. This very relative advantage creates the paradox of crisis. The deeper the systemic crisis, the more money flows into safe-haven dollar assets, paradoxically strengthening dollar hegemony. The fact that dollar hegemony has strengthened, not weakened, over the 15 years since the 2008 US financial crisis is evidence of this.

History also suggests a gradual timeline. Even after the British pound left the gold standard established by the British Empire in 1931, it took until the mid-1950s for its hegemonic status to be fully relinquished. It took over 20 years, even after enduring the massive upheaval of World War II. Therefore, viewing the shift in dollar hegemony in cycles of 5 or 10 years is unrealistic.

What should truly be a concern is not the bankruptcy of the US, but the fact that the policy tools used to prevent it are eroding the credibility of the financial system, consequently increasing the amplitude and shortening the cycle of US-led financial instability. Under conditions where an alternative financial order has not yet matured, this unstable coexistence can persist for a long time. If so, what is the foundation supporting this coexistence?

IV. Hegemony is Infrastructure, Not Currency

Debt is growing exponentially, foreign governments are withdrawing, and the market has become fragile, yet the dollar system remains intact. To understand the roots of this resilience, we must accurately identify the true foundation of dollar hegemony. Contrary to popular belief, that foundation is not the currency itself, but the three-tiered payment infrastructure behind it.

This infrastructure can be easily understood as a three-story building. The top floor is SWIFT (Society for Worldwide Interbank Financial Telecommunication). It is a messaging system connecting approximately 11,500 financial institutions worldwide, serving as a communication network for transmitting payment instructions. The middle floor consists of CHIPS (Clearing House Interbank Payments System) and Fedwire (Federal Reserve Wire Network). These are clearing systems where actual money is exchanged, handling about $6 trillion daily. The bottom floor is the Federal Reserve account, where all dollar transactions are ultimately settled. The freezing of approximately $300 billion in assets of the Russian Central Bank in 2022 occurred precisely at this bottom level (Federal Reserve accounts).

The three tiers are complementary and cannot be substituted for one another. Bypassing just one tier yields no practical effect. China's Cross-Border Interbank Payment System (CIPS) is a prime example. While this payment system has succeeded in bypassing the clearing tier, about 80% of its transactions are still messaged through SWIFT. This is why US secondary sanctions were effectively applied even when Russia used this payment system. Sanctions operate not at the stage of transaction processing, but at the stage of transaction visibility. Alternatives that do not replace the messaging tier cannot obscure this visibility.

Here, a seemingly contradictory phenomenon emerges. As US debt problems have surfaced, central banks worldwide have been reducing their dollar holdings. The proportion of dollars in reserve assets has steadily declined from 71% in 1999 to 57% in 2025. While this might suggest the world is moving away from the dollar, the reality of currency usage in international payments is the opposite. The share of the dollar in payments has actually increased from 33% in 2012 to about 50% in 2025. While dollar reserves are decreasing, the actual amount of dollars being transacted is increasing.

This discrepancy arises because 'holding reserves' and 'actually using' are entirely different matters. The decision of how much dollar reserves a central bank holds is a political choice. Diversifying reserve assets to distance oneself from the risk of US sanctions and asset freezes can be done at any moment if the will exists. However, the choice of currency for banks and corporations to settle trade payments and transfer funds is not a matter of choice but of infrastructure. Because there is no alternative payment system to the dollar yet, practical operations must use the dollar. Thus, at the very time when countries are politically moving away from the dollar, they are becoming technically more deeply entangled with it.

This paradox reveals the true locus of dollar hegemony. Even if countries hold fewer dollars due to debt concerns, their reliance on the dollar in practical sectors increases in the absence of alternative infrastructure. This means hegemony resides in the infrastructure that processes the currency, not the currency itself. Hegemony is not shaken by a reduction in dollar holdings; it is only shaken when infrastructure dominance is threatened. So, has alternative infrastructure reached a point where it genuinely threatens dollar dominance?

V. Alternative Order: Time, Twists, and Turns, and the Paradox In Between

Alternative infrastructure has evolved from partial bypass to full bypass over the past decade. China's CIPS has grown from 4 trillion yuan in 2016 to approximately 175 trillion yuan in 2024, an increase of about 44 times. The number of participating institutions has also expanded from 19 direct members at its launch to about 190 direct and over 1,500 indirect members, covering 124 countries. However, as noted earlier, this payment system only bypasses the clearing tier, with about 80% of messaging still relying on SWIFT.

Efforts to overcome this limitation are underway in the realm of digital currencies. Central bank digital currencies (CBDCs) are digital currencies issued directly by central banks. China's digital yuan is a prime example. By the end of 2025, the digital yuan had processed a cumulative 3.4 billion transactions, totaling approximately 16.7 trillion yuan (about $2.4 trillion), making it the world's largest experiment. However, most of these are domestic payments, and the reclassification of these as deposit liabilities in January 2026 indicates that their status is still fluid.

A decisive example is mBridge, a payment network used by multiple central banks. It involves the central banks of China, Hong Kong, Thailand, the United Arab Emirates, and Saudi Arabia, which officially joined in June 2024, bringing the total to five participating central banks. This payment network features its own messaging, multilateral netting, and settlement through the ledgers of participating central banks, bypassing SWIFT and dollar clearing. It is the first integrated alternative that bypasses all three tiers simultaneously. Cumulative transactions reached approximately $55.5 billion across over 4,000 transactions as of November 2025, a roughly 2,500-fold increase from the initial pilot in 2022 (approximately $22 million). About 95% of these transactions are settled in digital yuan.

Two developments have increased the weight of this payment network. First, the Bank for International Settlements (BIS), which had neutrally coordinated the project, withdrew on October 31, 2024. The official reason was that the project had reached its self-operational phase, but the timing was just one week after Russian President Putin proposed a similar alternative payment network at the BRICS summit in Kazan. Consequently, operational leadership has shifted from a neutral multilateral body to the central banks of BRICS participating countries, particularly China and the UAE.

Second, the BIS has redirected its resources to a Western counterpart payment network (Project Agorá). This parallel project, involving seven Western central banks and over 40 commercial banks, began testing in January 2026. While this project also addresses the same issue of cross-border payments, it is proceeding under Western-led governance and, crucially, aims to preserve the existing correspondent banking system rather than replace it. The international payment system is beginning to bifurcate into two distinct paths, maintaining the same form but diverging institutionally.

However, the scale of this bifurcation is still small. The cumulative settlement amount of $55.5 billion in this payment network is negligible compared to the approximately $6 trillion daily volume of the US clearing systems (CHIPS and Fedwire). Although 137 countries and currency unions (representing about 98% of global GDP) are experimenting with digital currencies, only a few small economies have actually launched general-purpose digital currencies. The foundation is being laid, but functional substitution is still a long way off.

In summary, establishing an alternative order involves time and twists and turns, and during the transition period, the absence of alternatives may paradoxically strengthen dollar hegemony. The past year under a potential second Trump administration exemplifies such a period. However, in the long run, the need to hedge against dollar decline remains, and alternative infrastructures are gradually taking shape.

VI. Conclusion and Implications for Korea

This unstable coexistence poses a particularly heavy burden for Korea. As noted earlier, the US securities held by the Bank of Korea constitute the majority of its foreign exchange reserves, already exposing it to silent losses. Furthermore, the $350 billion US investment package finalized in October 2025 is set to increase this exposure. This package actually heightens the exposure, as funds shift from short-term Treasury bills to high-risk, long-term projects with maturities up to 20 years, reducing the room for inflation defense.

The exposure does not end there. Korea faces dual pressure in trade between the US and China, a lack of hedging instruments in payment infrastructure as it does not participate in the China-led alternative payment network, and simultaneous exposure to a negotiation structure that binds security, currency, and trade.

The issue is not just direction but also speed. While Saudi Arabia, the UAE, India, Indonesia, and Malaysia are diversifying risk through alternative infrastructure while maintaining security relations with the US, Korea is accelerating its integration with the US camp, not only in security but also in economics and finance. Compared to the global trend of risk diversification, Korea's trajectory is moving in the opposite direction.

However, we must not jump to hasty conclusions. Dollar hegemony will not fade easily. Like the British pound, a hegemonic transition takes decades, and as crises deepen, money flows into the safe haven of the dollar, paradoxically solidifying its position. The alternative order is still incomplete, and filling that void will take a long time. Therefore, preemptively assuming a collapse and rushing to withdraw is reckless.

However, the fact that the dollar is not fading does not provide grounds for complacency. While the US will not go bankrupt, the policies implemented to prevent bankruptcy are creating chronic instability. The more the Fed absorbs Treasury bonds, the more these costs are silently transferred through inflation. This instability is not a temporary event but a structural constant that will persist for the next decade and beyond. The dollar remains robust, but the waves it creates are unlikely to subside; rather, they are likely to become more severe. This paradox is the challenge facing Korea.

Therefore, Korea's task is not to choose one side but to carefully calibrate direction and speed. There is no need to rush to exit, nor is there a need to carelessly deepen ties with the US simply because bankruptcy is not an option. Short-term responses that fluctuate with the dollar exchange rate and US-China relations cannot achieve this balance. What is needed is a national vision and strategy to navigate the next decade and beyond, where instability has become a constant, by remaining grounded in the dollar order while keeping the door open to alternatives, ensuring we are neither too hasty nor too complacent.■

References

Arslanalp, Serkan, Barry Eichengreen, and Chima Simpson-Bell. 2022. "The Stealth Erosion of Dollar Dominance and the Rise of Nontraditional Reserve Currencies."Journal of International Economics, 138.

Atlantic Council. 2026. "Central Bank Digital Currency Tracker." Accessed July 21, 2026.https://www.atlanticcouncil.org/cbdctracker/.

Dalio, Ray. 2025. How Countries Go Broke: The Big Cycle. New York: Avid Reader Press.

Kang, Myungkoo. 2026. "Testing the Alternative: mBridge, the Hengli Episode, and the Empirical Viability of a Bifurcated Financial Order." Working Paper, Baruch College, CUNY.

Miran, Stephen. 2024. "A User's Guide to Restructuring the Global Trading System." Hudson Bay Capital.

Rogoff, Kenneth. 2025. Our Dollar, Your Problem: An Insider's View of Seven Turbulent Decades of Global Finance, and the Road Ahead. New Haven: Yale University Press.

■ Kang Myungkoo_Professor of Political Science, Baruch College, CUNY.

■ Editor: Jhim Jaehyun_EAI Research Fellow
    Inquiries: 02 2277 1683 (ext. 209) | jhim@eai.or.kr