The tariffs Trump had been talking about on the campaign trail were top of mind, but for the most part, they were viewed as a negotiating tactic. Any turn toward protectionism was widely expected to push up the value of the dollar compared with other currencies. The rationale was that tariffs would lower demand for imported goods, since they would make them more expensive for American consumers, and over time result in fewer dollars being exchanged for foreign currencies.
But since Inauguration Day, the opposite has occurred. An index that tracks the dollar against a basket of major trading partners has fallen nearly 10 per cent in the past three months. It now hovers near a three-year low. The sharpest slide came after Trump announced large tariffs on nearly all imports in April. While he temporarily reversed course, the dollar has yet to recoup its losses.
International investors were consumed by the prospects of a “regime change” in the financial system and a “new world order.”
There are reasons not to read too much into its recent weakening. The US economic outlook has fundamentally changed. Businesses are “frozen” by tariffs, Christopher Waller, a governor at the Federal Reserve, said this past week as he warned about layoffs stemming from the uncertainty.
Economists have sharply scaled back their estimates for growth while raising their estimates for inflation, a combination that carries a whiff of stagflation. In that environment, it is not surprising that the dollar and other US assets appear less appealing.
Dollar depreciation – even if extreme – also does not necessarily translate to a loss of stature in the global financial system. There have been previous big drops in the value of the dollar that have not incited a wholesale shift away from the currency’s primacy, said Jonas Goltermann, the deputy chief markets economist at Capital Economics.
But at this year’s spring meetings, there was a palpable sense that something more ominous could be taking place. Joyce Chang, JPMorgan’s chair of global research, noted a disconnect between domestic and international participants at the conference that the Wall Street bank hosted during the week of the meetings.
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US-based investors appeared less concerned about a structural shift away from the country’s assets and more focused on the ways in which Trump could course-correct on his economic policies. International investors were consumed by the prospects of a “regime change” in the financial system and a “new world order,” Chang said.
Trump had recently escalated his attacks on Jerome Powell, the Fed chair, fanning fears about how much the administration would encroach on the central bank’s independence. That long-standing separation from the White House is broadly seen as essential to the smooth functioning of the financial system.
“The dollar’s role in the system was not ordained from above,” said Mark Sobel, a former Treasury official who is the US chair of the Official Monetary and Financial Institutions Forum. “It’s a reflection of the properties of the United States.”
Those include a large economy that transacts with the world; the financial system’s deepest, most liquid capital markets; a credible central bank; and the rule of law.
“I do believe that Trump is doing permanent damage,” Sobel said.
Few alternatives
It is hard to overstate the dominance of the dollar globally, meaning there are real limitations to how significantly private and public investors can diversify away from it, even if they want to.
Top European leaders, including Christine Lagarde, the president of the European Central Bank, have talked more readily about bolstering the prominence of the euro.Credit: Bloomberg
Most trade is invoiced in dollars. It is the leading currency for international borrowing. Central banks also prefer to hold dollar assets more than anything else, and by a wide margin.
“Anybody who’s looking for diversification has to be realistic,” said Isabelle Mateos y Lago, the chief economist at BNP Paribas. “Reserve assets, by definition, have to be liquid.”
Alternatives do exist, but they are hobbled by their own weaknesses. China lacks open, deep and liquid capital markets, and its currency does not float freely, tarnishing its appeal globally.
Top European leaders including Christine Lagarde, the president of the European Central Bank, have talked more readily about bolstering the prominence of the euro, something that is considered more plausible now that countries such as Germany are stepping up their spending.
But the amount of available euro-denominated safe assets pales in comparison with that of US capital markets.
Still, in the recent period of volatility, investors have found a number of places to take cover. The euro, Swiss franc and Japanese yen have been clear beneficiaries. Gold has rallied sharply too.
“You don’t need to have the role of the dollar as a reserve asset go to zero,” Mateos y Lago said. “A multipolar system can totally work.”
Burden or privilege?
When asked at last Wednesday’s event, which was hosted by the Institute for International Finance, whether the dollar’s reserve currency status was a burden or a privilege, Bessent said, “I actually am not sure that anyone else wants it.”
A weaker US dollar would make American products more competitive but will reduce the spending power for Americans abroad and increase borrowing costs.Credit: Bloomberg
Economists warn that Americans would be losing clear benefits if the government was too cavalier about the dollar shedding its special status.
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The country’s exporters would reap rewards, as a weaker dollar would make their products more competitive. However, that advantage could come at the expense of reduced spending power for Americans abroad and higher borrowing costs at a time when the government has huge financing needs.
Despite the pain that Americans may have to bear, the global financial system would be far more “resilient” if other currencies shared the dollar’s global role over time, said Barry Eichengreen, an economist at the University of California, Berkeley. During times of stress, that would mean multiple sources of liquidity.
However, three months into Trump’s second term, Eichengreen warned that a “dire scenario is now on the table” – a sharp sell-off of dollar-denominated assets into cash.
“A chaotic rush out of the dollar would be a crisis,” he said. “All of a sudden, the world would not have the international liquidity that 21st-century globalisation depends on.”
This article originally appeared in The New York Times.
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