HOW TRUMP MIGHT TOPPLE THE DOLLAR / THE ECONOMIST

Check your privilege

How Trump might topple the dollar

For the first time in many decades, the greenback looks vulnerable

Stocks down, yields down, dollar up. 

A reliable relationship between America’s listed companies, government bonds and the value of the currency has held, in moments of panic, for most of modern financial history. 

Until now.

The turmoil in financial markets over the past month, driven by an extraordinary rise in American tariffs, has been unsettlingly different. 

During the stockmarket slumps of 2008 and 2020, for instance, the dollar rose. 

When investors are fearful, they normally rush to the safety of American debt, bidding up the greenback in the process. 

This time round, investors are eschewing Treasuries. 

Yields on American ten-year government bonds, which rise when prices fall, have increased from 4.2% to as high as 4.5% over the past month. 

Meanwhile, the dollar has fallen by over 9% against a basket of other currencies since its peak in mid-January.

The breakdown of the once-solid relationship reflects the impulsiveness of the current American government. 

President Donald Trump’s belligerent trade policy, his administration’s incompetent policymaking and some of his advisers’ suspicion about the dollar’s global role have shaken foreign investors. 

Since they hold some $32trn-worth of American stocks and bonds, their opinion matters. 

Overseas demand not only lifts American stockmarkets, it pushes down interest rates on the government’s vast debts, making them manageable—a feature of dollar dominance known as “exorbitant privilege”.

Policymakers and investors everywhere once rolled their eyes at the idea of the dollar being dethroned. 

America’s economic heft, deep and profitable markets, openness to capital flows and reliable rule of law all helped make its position formidable. 

But in recent weeks, they have had to take the notion more seriously. 

Even imagining what might come next is hard. 

For eight decades, America’s currency has been the linchpin of trade and finance. 

About half of all lending across borders is in dollars, and the currency is involved in 88% of foreign-exchange transactions (see chart 1). 

The modern world has been built on the greenback.

Some members of the Trump administration would cheer if the dollar lost its crown. 

During his time as a senator, J.D. Vance, now the vice-president, was critical of the currency’s international role, arguing that the accumulation of American securities by foreigners had artificially lifted its value, damaging American industry. 

In November Stephen Miran, now head of the White House’s council of economic advisers, published a briefing suggesting the president could unilaterally tax Treasuries held as reserves overseas, so as to discourage investors from purchasing them. 

Rarely has a single paper so spooked central bankers around the world.

Policymakers overseeing foreign-exchange reserves had begun to diversify well before Mr Trump won re-election (see chart 2). 

Some fear America’s Treasury, and its ability to impose sanctions; others simply want to ensure their eggs are not all in one basket. 

The dollar’s share of global reserves has declined from 73% in 2001 to 58% today. 

Over the same period, a wide variety of currencies—including the Australian and Canadian dollars, the Swedish krona and the Swiss franc—have seen their share rise. 

Central banks have diversified out of currencies, too, buying more than 1,000 tonnes of gold in each of the past three years, an increase of more than 140% on the three before that.

Such diversification will only accelerate, reckons Gary Smith of Columbia Threadneedle Investments, who works with central banks and sovereign-wealth funds. 

Before America’s tariff barrage got under way, Mr Smith had expected that the dollar’s share of reserves would decline by another ten percentage points over the forthcoming decade. 

It is now clear that was a sizeable underestimate, he says.

Looking a little green

Over the past decade, international demand for dollar assets has mostly come from sources other than central banks, particularly giant government pension funds and life-insurance companies, many in Asia (see chart 3). 

These often have investments that run into the hundreds of billions of dollars, which are directed by committees that meet irregularly—meaning their strategy cannot turn on a dime. 

Despite this shock-absorbing feature, their enthusiasm for America has diminished. 

“Many international investors are fretting about the end of US hyper-exceptionalism,” says Huw van Steenis of Oliver Wyman, a consultancy. 

“The need for better diversification will be the lasting conclusion of whatever happens from here.”

Even if dollar dominance is only diminished at the margin—with institutions reducing their holdings of American assets, rather than fireselling them—that will make America’s fiscal profligacy much more difficult to maintain. 

The government runs a budget deficit worth 7% of GDP and its interest bill has ballooned in recent years, meaning higher bond yields would cause profound problems. 

On April 10th the House of Representatives approved the Senate’s plan for a budget that could add $5.8trn to deficits over the next ten years, according to the Committee for a Responsible Federal Budget, a think-tank. 

That is more, in cash terms, than Mr Trump’s first-term tax cuts, the response to the covid-19 pandemic in 2020 and President Joe Biden’s stimulus and infrastructure bills combined.

Overseas investors do not lack for reasons to park their money elsewhere. 

Yet those looking to limit exposure to Mr Trump’s whims face a challenge: the dollar has no obvious successor. 

Following the second world war, when Britain’s immiseration meant that the pound could not function as a global currency, the greenback was a perfect candidate to replace it. 

The currencies into which central bankers are today shifting their investments are relative minnows, with stock and bond markets too small to replace the dollar.

The euro was once seen as a possible replacement for the greenback. 

It may eventually prove to be so, if the continent’s politicians take advantage of the present opening. 

But investors will want proof that the design flaw in the currency union—credit risk in its government debt, arising from uncertainty about which borrowing will ultimately be backstopped by the European Central Bank—truly has been resolved. 

Germany’s debt, regarded as the safest kind by global investors, runs to $3trn or so, around a twelfth of the American total. 

Europe’s corporate-debt markets are also small.

Could the yuan climb the currency hierarchy? 

Although China’s economy is big enough to support a far larger role, progress in internationalising the currency has been halting at best. 

The yuan makes up just over 2% of global central-bank reserves, a figure that has declined since a peak four years ago. 

Chinese officials show no interest in scaling back their extensive capital controls, a move that would be required to entice foreign money. 

And the state’s occasional and unpredictable shakedowns of the private sector have been more damaging than any policy pursued by the Trump administration.

Instead of liberalising its currency, China wants to fortify its financial system against America. 

The People’s Bank of China has established swap lines with central banks overseas, and set up its own platform for overseas payments to reduce reliance on SWIFT, a messaging system for bank payments based in Belgium. 

Such experiments will not see the yuan supplant the dollar. 

But, according to Martin Chorzempa of the Peterson Institute for International Economics, another think-tank, they may limit the influence of the greenback beyond America’s borders, providing an alternative to countries that have been severed from Western finance.

The dirtiest shirt

If America’s government degrades the dollar’s role, whether by design or by accident, other countries may try to defend themselves by throwing up barriers to capital and falling back on new and less sophisticated financial networks. 

Without a true successor, the result would probably be a world of competing currency blocs, inadequate alternatives to Treasuries, barriers to trade and reduced efficiency. 

The past few weeks have been a taste of such a future—and they have not been pleasant.