HOW WORRYING IS THE WEAKENING DOLLAR? / THE ECONOMIST

Foreign exchange

How worrying is the weakening dollar?

In times of trouble, the greenback normally strengthens

A few months ago everyone on Wall Street was discussing the “Trump trade”. 

The consensus was that Donald Trump’s presidency would boost the outperformance of American stocks, raise Treasury yields and strengthen the dollar. 

So far this year, all three bets are deep in the red. 

American stock prices have plunged, while those listed elsewhere have held up far better. 

Treasury yields have fallen, with investors worried about faltering growth. 

Both trends accelerated after Mr Trump, on April 2nd, slapped swingeing new tariffs on virtually all of America’s trading partners.

Yet it is the weakening of the dollar that has shocked the most. 

After all, reasoning from first principles you would expect Mr Trump’s protectionism to strengthen the currency. 

By raising the prices Americans must pay for foreign goods, his levies make them less attractive and thereby induce Americans to sell fewer dollars to buy them. 

What is more, his assault on the global trading system threatens to unleash economic chaos. 

That sort of worry usually has investors clamouring for dollars, since they view the world’s reserve currency as a safe haven when markets are turbulent.

In fact, the clamour has all been to sell. 

The greenback’s value had already been falling for months relative to a basket of its rich-world peers (see chart). 

It then cratered as the scale of Mr Trump’s new duties became clear. 

Other currencies are ascendant. 

Measured in dollars, the euro has risen by 6% so far this year, the pound by 3% and the Japanese yen and Swiss franc—two other traditional haven currencies—by 8% and 6% respectively. 

Most bounced especially high after Mr Trump’s announcement on April 2nd. 

Even the long-battered Mexican peso has edged up against the dollar in recent months.

Watching all this, it is reasonable to worry that as Mr Trump pulls up the drawbridge, the dollar’s role in the global financial system is in danger. 

America’s rivals and allies alike have long sought alternatives that are beyond Uncle Sam’s reach, whether by developing new payment rails or agreeing to invoice trade in other currencies. 

Mr Trump’s past aggressive use of sanctions, for instance, against Iran in 2018 after blowing up a nuclear deal, make such endeavours all the more urgent. 

Perhaps, you might fret, the dollar’s present weakness is a sign that it is being dethroned.

For the moment, the fall in the greenback’s value is better explained by what foreign-exchange aficionados call the “dollar smile”. 

The idea is that America’s currency does well both when its economy is outperforming others, as in the past couple of years, and when its economy falls into a downturn. 

If America is in recession, goes the reasoning, other economies are also likely to falter, enhancing the dollar’s haven appeal. 

If the present threat to the global trading system worsens, such a downturn may follow. 

But so far traders are only betting that America’s growth will slow relative to the rest of the world’s. 

The dollar is therefore rolling down towards the middle of the smile.

That still has worrying implications the world over. 

The first is that American consumers should expect to suffer more under Mr Trump’s tariffs than they might have predicted. 

During his Senate confirmation hearing Scott Bessent, the treasury secretary, argued that the full cost of the levies would not be borne by consumers, as past experience suggested the dollar would strengthen in response. 

If that happened it would lower the dollar price of foreign goods, in part offsetting the additional tax. 

Instead, Americans buying imports will now have to pay the costs of both heavier duties and a weaker currency.

Foreign investors who own American assets are getting whacked, too. 

They have been used to the dollar strengthening during stockmarket routs, ameliorating some of the damage. 

Over the course of 2022, for instance, an investor in the S&P 500 index of large American firms who was counting in dollars would have clocked a 19% loss. 

One counting in euros would have lost just 14%. 

In 2025, this useful hedging relationship has fallen apart, with the dollar instead exacerbating losses from falling share prices. 

Since a peak in February, the S&P 500 index has fallen by 17% measured in dollars, but 21% in euros.

The silver lining, at least for those outside America, is that a weaker dollar ought to cushion some of the damage to global economic growth from Mr Trump’s protectionism. 

This is especially true for emerging markets. 

Research published by the IMF in 2023 found that a 10% increase in the value of the dollar tends, after a year, to reduce output in emerging economies by 1.9 percentage points. 

In rich countries, the hit is 0.6 percentage points. 

A mighty greenback slows growth by inhibiting global trade, some 40% of which is invoiced in dollars and which therefore gets more expensive when measured in other currencies. 

It also puts a squeeze on countries and firms that borrow in dollars, as in many emerging markets, by raising their debt-servicing costs in local currency.

Plenty feared that such a squeeze was on the way when the dollar rocketed in response to Mr Trump’s election. 

Now it has fallen back to earth, those fears will subside. 

Moreover, Treasury yields are falling and dragging other governments’ borrowing costs down with them. But this is hardly a lucky escape for any country. 

It is happening because America’s president wants to dismantle global trade. 

Should he succeed, the resulting turmoil would be likely to strengthen the dollar again—and for all the wrong reasons.