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Should Europe continue to fund U.S. federal debt?
Against a backdrop of heightened international trade tensions and a possible decoupling of leading economies it may be time to examine the economic validity of countries maintaining large foreign exchange reserves denominated in the US dollar. Specifically, in this paper we assess to what extent Europe should follow in the footsteps of China to trim its US dollar reserves invested in US Federal debt. Using a three-country dynamic general equilibrium model built around stylized representations of the United States, the euro area and China, we find that a cutback of foreign investments in US federal debt would make economic sense, but that a collapse of the dollar’s dominant position within the international monetary system is unlikely, unless China prioritises geo-strategic goals over economic rationales.