The Shadow of Trump’s Trade Policies: A Threat to the Dollar’s Reign
The immediate consequences of President Donald Trump’s trade war are becoming increasingly clear, casting a long shadow over the American economy. As prices for imported goods rise and economic growth decelerates, manufacturers are scaling back orders, small businesses reliant on Chinese suppliers teeter on the brink of collapse, interest rates are on the rise, Americans’ retirement savings are diminishing, and consumer confidence is waning. While the full extent of these consequences remains to be seen, even staunch defenders of the administration acknowledge that Trump’s tariffs will inevitably inflict economic pain in the short term.
However, the true concern lies in the long-term implications of Trump’s policies. The US economy has demonstrated resilience, rebounding from significant shocks twice this century. If the 2008 financial crisis and the Covid-19 pandemic failed to permanently diminish America’s living standards, it is reasonable to assume that the nation will eventually recover from the effects of Trump’s actions. Yet, there are legitimate reasons to fear that his policies will result in a lasting decline in American prosperity, particularly relative to the heights it might have otherwise achieved. Trump’s defunding of scientific research poses a threat to US innovation, while his restrictive immigration policies could stifle long-term economic growth.
Many financial analysts, however, believe that the greatest risk stems from Trump’s potential to permanently devalue the US dollar. The US dollar currently holds the position of the world’s reserve currency, the primary medium of exchange used in international transactions. This status grants the United States significant economic advantages.
To illustrate this point, consider a scenario where a Mexican farmer wishes to sell pork to a South Korean restaurant chain. The South Korean company likely does not possess a substantial amount of pesos, and the Mexican farmer has little use for the South Korean won. Therefore, a universally trusted and easily convertible medium of exchange is necessary. The dollar fulfills this role, enabling the South Korean company to exchange won for dollars, purchase the pork with those dollars, and the Mexican farmer to exchange the dollars for pesos.
The dollar’s reserve status maintains artificially high demand for the American currency and debt, thereby keeping borrowing and consumer costs unusually low. However, Trump’s unpredictable and aggressive trade agenda has eroded global investors’ confidence in both America’s economic and political stability, sparking discussions of "de-dollarization" among bankers and foreign governments.
While the dollar’s dominance in international finance is unlikely to end abruptly, Trump’s policies have increased the likelihood of its future displacement, while simultaneously driving down its current value. What makes this recent decline in the dollar’s value so alarming is that it was not anticipated. Most of the negative consequences of Trump’s trade war were widely foreseen. Tariffs virtually always increase consumer prices, provoke retaliatory measures from other countries, and depress stock values.
However, conventional economic wisdom held that Trump’s tariffs would strengthen the dollar. This prediction was based on the understanding that the international value of currencies is relative, with the dollar’s strength determined by how much foreign currency it can purchase. The dollar gains value as other major currencies lose value. Additionally, a nation’s currency value is partially determined by demand for its exports. For example, American importers must exchange dollars for yen to purchase Japanese products, which drives up the yen’s price on international currency markets.
In theory, Trump’s tariffs should have reduced Americans’ demand for foreign goods, leading to a decrease in demand for yen, euros, yuan, and pesos. This should have mechanically reduced the value of those other currencies, thereby increasing the dollar’s international value.
Furthermore, Trump’s trade agenda was expected to increase economic uncertainty. In recent decades, global investors have typically responded to economic jitters by purchasing US Treasury bonds, considered the world’s safest asset. These surges in demand for US Treasuries have historically driven up the value of the dollar, as investors require dollars to purchase US debt.
Trump’s advisors initially cited these dynamics to promote his trade agenda. Treasury Secretary Scott Bessent argued that Trump’s tariffs would not significantly increase the cost of imported goods, as his policies would increase the value of the dollar. However, this scenario did not materialize. To the surprise of both Trump’s supporters and critics, the US Dollar Index has fallen by approximately 9 percent since he took office.
This decline may be partially attributed to a temporary factor: the announcement of Trump’s tariffs prompted a surge in US imports, as American consumers attempted to stock up on foreign goods before the tariffs took effect. However, this does not fully explain the dollar’s decline. Even with the increase in imports, the dollar should not have fallen significantly in recent weeks. After all, Trump’s tariffs have triggered even greater global economic uncertainty than anticipated, due to their unprecedented size and scale.
Yet, instead of responding to this crisis by investing in US assets, capital appears to be flowing out of the United States, evidenced by the widening gap between the yields on American and German bonds. Currently, a 10-year US Treasury bond offers a return of approximately 4.18 percent, while the yield on a German 10-year bond is only 2.4 percent.
Typically, investors would respond to such a large gap by purchasing less German debt and more American debt, as US bonds offer a higher return and are generally considered as safe as, if not safer than, German bonds. However, despite high US interest rates and global economic uncertainty, investors appear to be moving money out of American assets and into European assets, with the dollar losing 5 percent of its value relative to the euro since the start of April.
This extraordinary development has led global analysts to question whether the dollar’s preeminence is nearing its end. The Bretton Woods Agreement established the dollar as the world’s reserve currency in 1944, but that framework for international trade collapsed in the 1970s. For the past half-century, the dollar’s dominant role in the global financial system has relied on America’s economic strengths and political stability, rather than any diplomatic accord.
The United States possesses the world’s largest economy, inspiring confidence among global businesses and countries that the dollar’s value will remain relatively stable over time. A vast and diversified economy is less susceptible to local shocks than a smaller economy or one heavily dependent on a single sector. Since international economic players have trusted the dollar to retain its value, they have been inclined to price goods in that currency and enter into contracts requiring payment in dollars.
The American economy’s size also ensures a high volume of buyers and sellers in its bond markets, making US Treasuries a relatively stable store of value. The depth of the Treasury market has historically been reinforced by America’s political stability, which has fostered confidence in its capacity and willingness to repay its debts. Together, these factors have made American debt a uniquely safe and scalable savings instrument for foreign central banks and investors, thereby strengthening demand for the dollar.
Trump’s policies have not eliminated America’s exceptional economic strengths. However, they have raised questions about the nation’s long-term prosperity, political stability, and creditworthiness. The irrationality of Trump’s tariffs has been particularly alarming to investors. The US government has declared that any country running a bilateral trade surplus with the United States is inherently cheating America, imposing tariffs as high as 46 percent on the exports of US allies in retaliation.
However, this reasoning is flawed. There is no reason why the United States should maintain a trade surplus with every country. There are numerous legitimate reasons why a foreign nation might sell more goods to Americans than it buys from them. For example, the people of Bangladesh cannot afford to purchase large quantities of US-made goods, while Americans can easily afford to buy significant amounts of Bangladeshi clothing.
The administration paused its reciprocal tariffs for 90 days, but refused to revoke them entirely, retaining a 10 percent universal tariff. Moreover, the US abruptly increased its tariffs on Chinese goods to 145 percent, effectively halting trade between the world’s two largest economies.
The US government’s ability to pursue such erratic and hostile policies has cast doubt on its competence as a steward of growth and its reliability as an economic partner. As Mark Sobel, US chair of the global economic think-tank OMFIF, stated, "The trade war is just the latest example of this administration’s contempt for the rest of the world. Being a trusted partner and ally is a key pillar of the US dollar’s dominance, and has been tossed to the wind."
If Trump disregards conventional economic reasoning, norms, and international agreements, who can be certain that he will not undermine the Federal Reserve’s independence or even consider defaulting on America’s debts? This line of thinking appears to have driven investors to seek safe havens outside the United States, with the Swiss franc, yen, and gold experiencing increases in value as the dollar has declined.
While the dollar’s status as a global reserve currency offers benefits to the US, such as reducing the global competitiveness of American firms, its displacement as global reserve currency would likely impose significant economic costs on American households. The high demand for American assets due to the need for dollars in international transactions has allowed the United States to run large budget deficits without incurring commensurate increases in borrowing costs.
The end of dollar dominance would force the US government to pay higher interest rates, exacerbating the burden of America’s debt and making it more difficult to avoid tax hikes or entitlement cuts. A weaker dollar would also reduce Americans’ living standards.
While the world is only de-dollarizing in relative terms, and the US Dollar Index remains higher than in early 2021, the lack of a viable alternative remains a significant obstacle to the dollar’s displacement. Only a similarly large economy with a trusted political system could support a reserve currency as effective as the dollar.
The European Union lacks a centralized treasury or debt-issuing authority, undermining its ability to manage its collective economy during times of crisis. China imposes heavy restrictions on the movement of money across its borders, making the yuan unsuitable for global reserve status.
Despite these challenges, discontent with the dollar system has grown in recent decades. The United States has repeatedly weaponized the dollar’s centrality to the global financial system, forcing other countries to abide by its sanctions or lose access to the US banking system.
Trump’s actions have expanded global governments’ and investors’ desire for an alternative system. If the European Union were to move to greater fiscal union or China to embrace greater financial openness and political reform, the world could transition to an international monetary system with multiple dominant currencies, diminishing the dollar’s role.
For ordinary Americans, the immediate concern is that the dollar appears poised to weaken further in the coming months and years. Goldman Sachs predicts that the dollar will lose another 6 percent of value relative to the euro and yen, with Trump’s tariffs already reducing Americans’ purchasing power. While his supporters claim that this "short-term pain" is necessary for "long-term gain," Trump’s trade agenda will likely make Americans poorer both now and in the future. The only question is how extensive and reversible the damage will be.
