As America steps back, small nations’ currencies step up

Over the past decade, the United States has reconsidered its role in the international order. This has led to tensions with allies who use the U.S. dollar for trade and hold it as a reserve currency. The U.S. has caused major issues with tariffs, conflicts in the Middle East, and the weaponization of international payment systems.

If the U.S. dollar loses its influence, smaller, well-governed countries with open capital markets and strong institutional rule of law could benefit most. There are three main reasons for this. First, if the U.S. no longer provides a currency backed by a strong Federal Reserve and rule of law, investors will seek out currencies with these features.

Smaller countries with open capital markets and developed currency derivative markets offer these features backed by strong institutions. Second, technological changes like stablecoins and central bank digital currencies (CBDCs) will make it easier for international investors to bundle and diversify their exposure to small-country currencies with near-instant settlement.

Large, institutional investors are hesitant to use smaller currencies due to lack of network effects and liquidity concerns. However, with blockchain-related products, end users will be able to transfer small currencies instantly, mitigating any liquidity or settlement issues. Lastly, small-country currencies' greatest weakness is actually their greatest strength.

Because a small nation does not have the power to kick users off their rail networks like the U.S. has done with aggressors, end users don't have to worry about political weaponization of their currency. With rising debt loads and 10-year bond yields, the demand for a well-governed currency remains high. Investors are already shifting their foreign reserves towards currencies like the Australian dollar and Canadian dollar.

While the U.S. dollar may not lose its standing as the primary world reserve currency, smaller nations with strong institutions stand to benefit most from this new international trade environment.