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The fact that even Liz Truss, whose halcyon days as British prime minister lasted less than seven weeks, cites this as one of her main fears shows just how deep the concern over the dollar’s declining global role is. is propagated. Then again, given Truss’ ability to understand financial markets and ensure a stable currency, one could also argue that this is strong evidence that the concerns are misplaced.
Indeed, although there appears to be a new wave of concerns that upward pressure on prices, geopolitical risk and the United States’ external ties will drag the currency down and reduce its global influence, so far there is not much evidence of this. The dollar strengthened this week as the Federal Reserve’s interest rate cut forecasts were downgraded due to unexpectedly high inflation. This is the normal reaction of a currency to interest rate differentials. If there were fears that US inflation would spiral out of control and shake confidence in monetary policy, we might expect a weakening, not a strengthening, and US growth to underperform rather than outperform others. savings.
In fact, recent episodes of heightened geopolitical and financial tensions have tended to show that the dollar’s role as a safe haven has survived, even when the damage is self-inflicted. The currency even rallied, or at least held firm, when the U.S. Congress threatened to default on Treasuries during the 2021 and 2023 debt ceiling crises.
The most recent call inside the House concerns the prospect, raised in an article this month in Politico, of a new Trump administration attempting to use a devaluation of the dollar to reduce the trade deficit, by particularly with China, in addition to the customs duties it imposed during the previous period. the first term. In reality, a resumption of the currency wars of the 2000s and 2010s is unlikely to do much to reduce the U.S. deficit or weaken the dollar’s global role in bank financing, payment systems, and reserves.
There were some half-hearted attempts to pressure trading partners on currencies during Donald Trump’s first term. His administration accused China and Vietnam of manipulating their currencies, measures that had little or no effect as reasonable people predicted. He inserted a section on currency manipulation into the rewritten NAFTA deal with Canada and Mexico, but they have floating exchange rates anyway.
It turns out that the dollar has generally strengthened under the Trump administration. The theory is that currencies rise in response to the imposition of import tariffs, since nominal exchange rates adjust to compensate for the change in competitiveness. (Macroeconomic policy in an open economy is difficult.) Research by economists Olivier Jeanne and Jeongwon Son notes that in 2018-2019, the United States imposed new tariffs of 15% on average on its imports from China, but the renminbi depreciated by 7%. cent to the dollar. The authors suggest that Trump’s tariffs were responsible for one-fifth of the dollar’s actual appreciation (i.e., trade-weighted) and two-thirds of the renminbi’s actual fall during his term.
It will be difficult to explicitly shift policy toward weakening the currency, especially if Trump also continues to impose new tariffs that will tend to push up the exchange rate. Unless he takes control of the Federal Reserve and orders it to ease monetary policy or facilitate large-scale monetary intervention, there is not much scope for unilateral depreciation.
And any call from Trump for international cooperation will be met with hollow laughter. Barack Obama’s administration, which rode a wave of global goodwill far greater than Trump’s, spent years at the IMF and the G20 asking other governments to commit to reducing current account imbalances and to avoid competitive devaluations of their currencies. It completely failed.
It is, of course, possible that a Trump administration will succeed in destroying the American economy and government to such an extent that it ends up weakening confidence in the system that underpins the dollar. Perhaps a truly dysfunctional Congress could default on Treasuries during a debt ceiling crisis, in which case all bets would be off – although such events usually involve a Republican Congress trying to exercise pressure on a Democratic administration.
But it is truly remarkable how, with the exception of a few small-scale bilateral agreements in other countries to evade US financial sanctions, the dollar has remained the default for financial plumbing, banking and global reserves.
Inflation is falling more slowly than expected. This is a manageable challenge for monetary policy, not a global currency crisis. A Trump White House transforming himself into an exchange rate warrior and a tariff warrior alone will not end the status of the dollar. It is more likely that it will result in a misguided administration, once again wrestling with a policy it seems not to understand and testing without breaking the remarkable resilience of the currency it inherited.