The dollar may not be deposed, but Trump is giving it his best shot

(Originally published April 15 in “What in the World” The U.S. dollar continues to suffer from Trump’s policies.

The dollar index has fallen almost 9% since Trump’s inauguration, offering yet another measure of, as noted in yesterday’s missive, “just how severely U.S. President Donald Trump is sabotaging U.S. economic and financial strength and undermining faith at home and abroad in the stability and even durability of the U.S. government as a borrower and the United States as a democracy.” To that, I should add the threat he poses to the rule of law.

The dollar, like U.S. government bonds, has long been the world’s go-to when times get tough. There’s always been a certain paradox to this. The U.S., after all, runs one of the world’s most persistent current-account deficits: roughly 3% of GDP in 2023. That’s slightly worse than Eswatini, but better than the United Kingdom’s 3.3%. That’s usually a textbook recipe for a weak currency, but the greenback has been buoyed by two bedrock assumptions: first, the strength and dynamism of America’s economy; and second, the stability of its government and rule of law. The first assumption guaranteed demand for dollar-denominated assets, such as stocks and property. The second reinforced faith in the dollar as a fiat currency that its issuer would always be around to honor. After all, investors assumed, no matter how bad the economy might get, there was virtually no risk of tanks rolling down Pennsylvania Ave. to overthrow a democratically elected U.S. government.

No more. Donald Trump has managed to shatter both of those assumptions in less than 90 days as U.S. president. In truth, he shattered that last one on Jan. 6, 2021. His schizophrenic tariff policies shattered the first. In his latest spasm, he paused tariffs on electronics imports on Friday, then moved Monday to impose tariffs on imported pharmaceuticals and semiconductors, even as he pondered pausing tariffs on car imports, while threatening more tariffs on Mexico for allegedly withholding water from Texas.

The dollar’s drop in response has puzzled economists—and anyone with a basic understanding of the economic principles alluded to two paragraphs above. Economists assumed that, because tariffs would reduce imports, the dollar would appreciate in anticipation of a lower trade deficit and, with it, a lower current-account deficit.

That’s the simple part of the explanation. Another is that, because tariffs raise prices and are thus inflationary, they would prevent the Federal Reserve from cutting interest rates, keeping yields on U.S. bonds and other assets relatively high and thus support demand for dollars to buy them.

But Trump’s tariffs are anything but simple. In addition to being much higher than most people anticipated, they’re also wildly unpredictable. No one, not even Trump, seems to know how high they’ll go or how long they’ll last. That uncertainty is paralyzing spending and investment. One could thus argue that the damage to economic growth from Trump’s policies has far exceeded their expected inflationary impact. And since most imported goods aren’t made in America and thus can’t be substituted, the added cost of tariffs will hurt economic growth as American consumers and companies either absorb the cost of tariffs or reduce spending on imports. That would compel the Fed to cut rates.

Either way, Trump’s policies have prompted a pell-mell rush for non-U.S. assets. Having shattered the illusion in both U.S. political stability and its economic dynamism, Trump has not only demolished demand for dollar-denominated assets, but also destroyed investors’ faith in “American exceptionalism.”

This is illustrated by two very unusual phenomena: first, when U.S. stocks tumble because of bad news, the dollar usually holds up. The same is true for U.S. government bonds: even when they go down, the dollar usually retains its safe-haven status. But that appears to be breaking down.

This is a big deal. But there are lots of caveats here. First, the dollar hasn’t fallen as much as might be expected given the damage Trump has caused. Even after its 9% tumble, it’s only back to where it was in mid-2023. It has fallen much lower in periods when American institutions and the American economy were arguably in much less peril.

Second, like the market for U.S. government bonds, the dollar is insulated to some extent by the sheer volume of supply. Thanks to the U.S. Treasury’s need to keep printing dollars to spend and because of their status as the preferred medium in global exchange, there are more U.S. dollars in circulation than any other currency. That makes it more liquid, easier to use and to trade without major changes in its value. So, will the sawbuck finally be deposed as the world’s favorite currency? Probably not. But never say never. Trump’s attack on global trade will undoubtedly leave a scar.

Trump has managed to make other economies look attractive by comparison—even economies until recently thought to be facing their own inexorable decline, such as China and Europe. In part, this is because his antagonism has managed to galvanize those governments into potentially unprecedented stimulus. But it’s also in part because investors can no longer cling to U.S. stock markets as a relatively safe and liquid proxy for a globalized global economy. Trump is uprooting global supply chains in a vain hope that by eliminating trade deficits, he’ll somehow revive U.S. manufacturing prowess. In the autarchic future Trump is lurching towards, investors who want to track global growth opportunities need to invest locally.

Achieving this diversification will require a massive shift in existing stock allocations. Many analysts and pundits have been worrying about how concentrated global equity investment has become into the U.S., and in the seven leading U.S. tech stocks in particular. Thanks in part to faith U.S. economic strength, the U.S. stock market is much larger in terms of capitalization relative to the rest of the world than the U.S. economy.

And thanks to investors’ perennial faith in the ever-imminent earnings bonanza to come from faster chips and more powerful computing, more of that U.S. market capitalization is concentrated in just seven companies’ stocks: Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia, and Tesla.

The great unwinding out of Trump’s Fortress American already appears to be underway. As a result, China and Germany’s benchmark stock indexes have been hit hard since March, but they’ve still outperformed the S&P500 over the past three months even though both those economies also stand to be pummeled by Trump’s tariffs.

So, buckle up, Buttercup.