Published on Jan 27, 2026 • Updated on Sep 12, 2026
This article was written by Adem Tumerkan
Content Editor, Dunham | 2025 ThinkAdvisor Luminary Award Winner | 2026 Wealthies Finalist — Thought Leader of the Year | Macroeconomics, markets, geopolitics & global trends
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The Impossible Trinity – or known as the policy trilemma1 - is an economic principle that says a country cannot have all three of the following at the same time:
If a country goes for all three, it'll risk chaos in its economy.
Hong Kong set its own . Instead, the Hong Kong Monetary Authority (aka the HKMA, the central bank) has to follow whatever the U.S. does with interest rates. - China directly controls how money moves in and out of the country – unlike both the U.S. and Hong Kong. This is known as a “closed capital account” – think of it like having gates around their money to stop people from sending large amounts of it abroad or letting too much foreign money come in.So, the deal is simple – a country must pick two and stick with it. Trying to have it all? Well, that’s when things begin to break.
This may seem complex, so let’s look at some real-life examples. . .
The U.S. made its pick in the Impossible Trinity game. It decided on two things:
The U.S. chose free capital flow and independent monetary policy. That means the Federal Reserve sets rates on its own terms — and anyone in the world can buy or sell dollars freely, at any time.
But here’s the trade-off. . .
The U.S. doesn’t (and can’t) have a Fixed Exchange Rate. This means the value of the U.S. dollar can go up or down, depending on what’s happening around the world.
For example, there’s no policymakers pegging the dollar to the euro or yen to manage it’s relative value.
This poses an issue because, as I highlighted in “The U.S. Dollar’s Global Dominance: Perks, Pitfalls, and the Perils of Losing It,” many foreign countries - particularly China, Japan, and the U.K. - park their excess savings in the U.S., artificially pushing the dollar’s value higher.
Critics rightly argue that the U.S.’s large chronic deficits should cause a much weaker dollar. Yet, a glut of foreign money easily parked in the U.S. keeps it strong, making U.S. exports more expensive and less competitive globally. Meanwhile, this dynamic allows these countries to export more to the U.S., fueling America’s trade deficit so that they can boost their own growth.
This is the price the U.S. pays for playing the Impossible Trinity game.
Hong Kong chose a fixed exchange rate and free capital flows. Since 2005, the Hong Kong dollar has been pegged between $7.75 and $7.85 to 1 USD. Capital moves freely in and out - which makes Hong Kong a premier hub for international trade and finance.
But here’s the catch:
Why? Because if the U.S. raises its interest rates, the U.S. dollar becomes stronger. Hong Kong then has to raise its rates too, to keep the HKD tied to the USD. And vice versa if the Fed cuts interest rates.
But this can cause problems.
For instance, imagine if the U.S. raises rates to slow things down because they’re worried about inflation, but Hong Kong is in a recession. Hong Kong would have to raise rates too, which could make their economy even worse.
This is exactly what’s happened ever since the Fed began tightening interest rates in December 2015. Since then, Hong Kong’s economy has been struggling under the weight of following the Fed into tightening. As the chart below shows, it’s been roughly stagnant for the last 8 years (once the Fed began tightening for the first time since the 2008 financial crisis).
Or, if Hong Kong is booming and needs to cool down, but the U.S. is lowering rates, Hong Kong might end up overheating and spurring more and more inflation.
That’s the price Hong Kong pays for choosing these two policies.
Note: Saudi Arabia follows this exact model that Hong Kong does, maintaining a hard peg to the U.S. dollar.
China, on the other hand, has taken a distinctly different approach.
China chose a fixed exchange rate and an independent monetary policy. The People's Bank of China doesn't explicitly peg the yuan to the dollar, but it heavily manages it - a so-called 'shadow peg.' This keeps Chinese exports cheap and supports a heavily subsidized manufacturing economy.
But here’s the catch:
Why does China do this?
Because if people could move money freely, it would greatly influence the yuan’s value. For example, if China lowers interest rates to help its economy, investors might prefer to send their money to the U.S., where interest rates are higher. That would cause the yuan’s value to drop because too many people are selling yuan to buy U.S. dollars. This could break their shadow peg.
Thus, by controlling money flows, China can keep its system stable.
Note: China actually operates two versions of its currency - the onshore yuan (CNY) and the offshore yuan (CNH). This dual system lets China manage the currency domestically while allowing limited use abroad.
The 1997 Asian Financial Crisis shows what happens when a country – Thailand specifically - tries to achieve all three corners of the Impossible Trinity (and failed, miserably)3.
The IMF was forced to intervene with bailout packages to try and stabilize Asia.
Thailand’s miserable failure highlights the risks of trying to "have it all" when it comes to the Impossible Trinity. At the end of the day, you’re forced to pick two.
So why does the Impossible Trinity matter for the U.S. dollar and the talk of de-dollarization?
Because China’s approach shows why the yuan won’t replace the dollar as the world’s reserve currency anytime soon, despite what you hear in the media.
China fixes its exchange rate and runs its own monetary policy. But it does this by shutting off capital flows - a major problem.
A reserve currency must allow money to move freely and quickly, without restrictions. China’s capital controls make the yuan unappealing to central banks and investors who value the U.S. dollar’s liquidity.
Moreover, if China loosened capital controls while maintaining a peg and independent monetary policy - trying to achieve all three sides of the Impossible Trinity - it would risk draining its foreign reserves. History, particularly Thailand’s 1997 collapse, shows this strategy is unsustainable.
In fact, I believe China avoids lifting capital controls because Beijing fears a massive outflow of money. Financially repressed households would likely rush to move their savings abroad into more attractive markets, putting deep pressure on the yuan’s peg.
Of course, China’s $3+ trillion in foreign reserves could sustain this approach for a time4. But eventually, the limits of the Impossible Trinity will catch up.
Thus, until Beijing embraces free capital flows - which means giving up either the peg or monetary independence - the yuan can't challenge the dollar at a structural level.
Remember, politics, de-dollarization rhetoric, and geopolitics don't change math.
Why can't China's yuan replace the U.S. dollar as the world's reserve currency? China keeps tight control over its capital account, and that's the main roadblock. A true reserve currency needs free capital flow, so investors can move money in and out with no restrictions. China won't allow that because it would mean giving up control over its exchange rate and monetary policy. As of late 2025, the yuan held under 2% of global reserves, a share that's held steady for years.
What percentage of global reserves does the yuan hold right now? The yuan held 1.95% of allocated global foreign exchange reserves in the fourth quarter of 2025, according to IMF data, edging up slightly to 1.99% in early 2026. The U.S. dollar, by comparison, held about 57% of reserves over the same stretch. Even with years of Beijing pushing yuan use abroad, that gap has barely closed since China's currency joined the IMF's reserve basket in 2016.
Is the yuan's global use growing or shrinking in 2026? It's growing, just slowly. Payment data from SWIFT shows the yuan's share of global transactions climbed from around 2.7% in late 2025 to roughly 3.1% by mid-2026, moving it up to fifth place among world payment currencies. Its reserve share ticked up too, from 1.95% to 1.99% over the same period. That's real progress, but it still leaves the yuan far behind the dollar and euro.
What is the Impossible Trinity, and how does it explain the yuan's limits? The Impossible Trinity says a country can't have free capital flow, a fixed exchange rate, and independent monetary policy at the same time. It has to pick two. The U.S. chose free capital flow and monetary independence, letting the dollar float. China chose a managed exchange rate and monetary independence, so it keeps capital controls in place. That tradeoff is why the yuan can't function as a true reserve currency yet.
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