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Since the 1970s, banking regulators have worked together through the Basel Committee on Banking Supervision to set minimum standards for internationally active banks. The latest agreement, known as Basel III, came in the aftermath the 2008 financial crisis. The United States adopted the initial Basel III rules in 2013. A decade later, U.S. regulators proposed the “Basel Endgame” to implement the final rules agreed in 2017 and 2019.

The 2023 Basel Endgame proposal included a nearly 20 percent increase in capital requirements for the largest banks. The banking industry fiercely opposed the initiative, effectively killing it in its original form. As of this writing, the fundamental question of how or whether the United States will implement the final Basel III standards remains unresolved. This is not just a technical regulatory matter. The outcome will affect credit availability, economic growth, and financial stability—while determining whether the United States maintains its leadership in international financial standard-setting.

In our view, the Basel Endgame proposal unnecessarily conflated two distinct questions: (1) whether the United States should comply with international regulatory standards, and (2) whether the United States should raise large banks’ capital requirements. While there are strong grounds to answer both questions in the affirmative, they need not be addressed together. That is, the United States could implement the final Basel III standards without raising overall capital requirements.

It was only a few months ago that everyone was focusing on the U.S. economy’s exceptionally favorable fundamentals: growth was solid; driven by migration, the labor force was expanding; inflation was receding; and business formation was robust. Adding to this, U.S. capital markets were the envy of the world, as were the research centers that were advancing the technological (e.g. productivity) frontier. These elements of American exceptionalism helped push the real effective value of the dollar to a near-40-year peak in January.

How quickly things change. Chaotic policies – tariffs, overtly preferential treatment, deportations, attacks on universities, slashed research funding, and general increases in policy uncertainty – risk inhibiting growth, sparking inflation, retarding investment, and stunting technological development. Unsurprisingly, this disturbing new mix is leading many people to anticipate a decline of the dollar and to speculate about the loss of safe-haven status for U.S. Treasuries (see our recent post).

In this post we discuss key fundamentals — including heightened policy uncertainty, dollar overvaluation, and the unsustainable fiscal path — that encourage expectations of a shift away from dollar assets and lend credence to private forecasts of a large dollar depreciation. If these projections prove correct, the key question is whether dollar adjustment will be smooth, or whether there will be a will there be a “sudden stop” where global investors abruptly halt (or even reverse) capital flows into the United States?