Magical thinking is indispensable to understanding Team Trump\u2019s economic policymaking. The White House often seems to believe two opposing policies can work together while one policy can do two or three contradictory things.<\/p>\n
A heavy dose of hocus pocus will be needed to make the administration\u2019s dollar policy work in the interest of the United States, for it appears that they want to end the US dollar\u2019s supremacy in global finance.<\/p>\n
At least some part of it does. True, Donald Trump<\/a> has warned countries not to replace the dollar, or else<\/a>. And, reportedly, some members of the administration want to encourage more countries to adopt the dollar<\/a> outright. But what is also true is that Stephen Miran<\/a>, the president\u2019s chief economic adviser, on leave to act as board member of the Federal Reserve, thinks the dollar\u2019s position as the main reserve currency of the world is an undue burden for the US and a principal driver of the large trade deficit that Trump finds so odious<\/a>.<\/p>\n \u201cAmerica runs large current account deficits not because it imports too much,\u201d Miran wrote last year<\/a>. Rather, it imports too much because it must export Treasury bonds to provide other countries with assets in which to park their reserves. This leads to \u201cpersistent dollar overvaluation that prevents the balancing of international trade.\u201d<\/p>\n The quote brings to mind Jenny Holzer\u2019s 1980s Times Square billboard, with its dry appeal to a higher power: \u201cprotect me from what I want<\/a>.\u201d<\/p>\n It is not impossible that Trump & Co. could effectively debase the dollar. They could do it through policy choice or sheer incompetence. Arguably, they have already started. They will not like the outcome.<\/p>\n For sure, foreign countries will suffer if US Treasury bonds quit their job as safe liquid assets in which to park reserves. There are no good alternatives out there. The old hope that the euro would rival the dollar has been stymied by Europe\u2019s fragmented capital markets. A quarter century from the euro\u2019s launch there is no euro T-bond. The renminbi, meanwhile, can\u2019t play a leading role in global finance while China retains capital controls that keep money from freely flowing in and out.<\/p>\n The dollar is valuable not only as a financial haven. A recent research paper<\/a> points out that roughly two thirds of countries in the world stabilize their currency against the dollar to provide insurance against global economic shocks. Because the US market is so large, the value of the dollar affects the price of traded goods: shocks that appreciate the dollar also raise their price. Holding dollars or, indeed, aligning one\u2019s currency with the dollar \u2013 can help hedge against these economic fluctuations.<\/p>\n The cost of undermining the dollar to the US would also be enormous. For starters, it stands to lose world influence, alongside its main tool for economic coercion, which allows it to limit enemies\u2019 access to the financial system. Moreover, the US would relinquish what former French president Valery Giscard d\u2019Estaing called the US\u2019s \u201cexorbitant privilege\u201d.<\/p>\n Miran is not wrong that the dollar\u2019s reserve status draws a lot of money into Treasury bonds. But that is a gift. It allows the government to fund its massive debt<\/a> \u2013 120% of GDP \u2013 at a low interest rate. The privilege also implies that the US earns more<\/a> on its holdings of foreign assets than foreigners earn on their US holdings. Indeed, curbing the US current account deficit would be much more difficult if the US lost its reserve status because its interest rate edge would shrink or disappear altogether.<\/p>\n Which brings us to the question, will Trump knock the dollar off its perch? Its supremacy has been eroding. These days it accounts for 58% of global foreign exchange reserves, down from 74% at the turn of the century. The interest rate advantage Treasury bonds have over the debt of corporations<\/a> or other countries<\/a> has shrunk over time.<\/p>\n And Trump\u2019s trade war will reduce the dollar\u2019s insurance powers. By curbing US imports, Trump\u2019s tariff wall will dampen the relationship between the dollar and the price of traded goods\u2013reducing its value as a hedge against economic shocks. \u201cWe\u2019re basically reducing the impact that we have on the world market, and by reducing the impact that we have on the world market, we also reduce the dollar safety property,\u201d notes Tarek Hassan<\/a> of Boston University.<\/p>\n And that gives countries and investors less of a reason to peg their currency to the greenback or hold dollar assets. Hassan estimates that the tariffs imposed so far have raised US interest rates by half a percentage point, a not-irrelevant amount given that rates are in the 3-4% range. Developing countries have been swapping out of dollar debt<\/a> in recent months, turning to currencies with lower interest rates like the Swiss franc and the renminbi.<\/p>\n The notion that the president\u2019s trade war might undermine the dollar\u2019s pre-eminence struck hard on \u201cLiberation Day\u201d<\/a> in April when Trump first announced his round-robin \u201creciprocal\u201d tariffs. US stocks, bonds and the dollar plunged in unison, like risky emerging market assets, breaking the ironclad rule of modern finance that shocks to the system, whether coming from the US or some faraway developing country, benefit Treasury bonds and the dollar as the world\u2019s safe haven, where governments, investors and regular people park money in times of unrest.<\/p>\n