Questions about whether President Donald Trump’s tariffs spell the end of dollar dominance and the safe-haven status of US Treasuries elicited tremendous hand-wringing by market participants and officials at the International Monetary Fund-World bank spring meetings. And rightly so.
But while critical and legitimate concerns have been raised about Trump’s chaotic actions and policies, and recent developments may indeed be setting in motion a gradual decline in dollar dominance, the hand-wringing is overdone.
Fundamental components of dollar dominance are under attack
Since Trump’s disastrous tariff rollout, financial markets have understandably been on edge. A risk-off environment generally is seen as benefitting the dollar and bond prices. But in the latest period, stocks and bond prices fell sharply. Moreover, while most analysts had expected the dollar to rise alongside the announcement of tariffs, in fact the dollar fell, reflecting concerns that tariff policy would cause a recession and a ‘sell America’ loss of confidence in the administration’s chaotic policy-making.
Market participants are fully justified in worrying that dollar dominance may wane, and sharply, given that the administration appears uncommitted to protecting the properties that give rise to that dominance. The dollar’s global role is predicated not only on the huge size of the US economy, but also broadly sound macroeconomic policies, the depth, liquidity and openness of US capital markets, good rule of law, sound institutions and America acting as a trustworthy ally and partner.
These are all under attack.
US fiscal debt and deficits are high and the unsustainable fiscal trajectory is on the wrong track. Yet Trump plans to cut taxes, which will worsen the outlook. Trump’s attacks on Federal Reserve Chair Jerome Powell, along with challenges to representatives at other agencies, raise questions about the independence of the Fed and strength of US institutions.
Stephen Miran’s misguided Mar-a-Lago Accord proposal raises questions about whether the administration might eventually use coercive capital markets measures to help finance the US government. Trump’s attacks on Europe, Canada and others, his volte face on supporting Ukraine and his casting doubt on US adherence to Nato commitments raised questions about whether the US can be a trusted partner and ally. Lurking in the background is America’s overuse of financial sanctions.
No real alternative to the dollar
It is little wonder that questions arose about whether these developments mark the beginning of the end of dollar dominance and the dollar’s safe-haven status.
But the stories about the death of dollar dominance are premature. It will continue for the foreseeable future given a lack of viable alternatives. The dollar’s role may ease as markets look for alternatives such as gold, boost allocations of other currencies at the expense of the dollar or pursue other asset classes such as private credit. But significant near-term declines are unlikely.
Asset managers adjust portfolio benchmarks slowly and gradually, though they are likely to modify dollar benchmarks. The euro may benefit, but its rise will most likely be limited given the lack of euro safe assets, as distinct from Bunds and French government bonds (OATs) for example, lack of economic dynamism and fragmented European capital markets. The renminbi will make little headway given China’s economic headwinds, capital controls, inconvertibility and questionable rule of law. There’s something to be said for the adage in foreign exchange markets about the dollar often being the ‘least ugly’ currency.
Gold is in vogue but there are limits to how much one can load up a portfolio. There are also limits to how much portfolios can be bulked up with Australian and Canadian dollars and Swiss francs.
‘Exorbitant privilege’
While global policy-makers have long decried the dollar’s purported ‘exorbitant privilege’, other countries have hardly done what it takes to get in on the action. And they protest too much – they benefit from having a medium of exchange that allows low transaction costs for global trade and finance, let alone a usually decent store of value.
The dollar has faced huge pressures in the past. It fell sharply in 1978 amid a loss of confidence in US economic policy-making. In 2008, the dollar fell towards $1.60 to the euro during the global financial crisis amid heavy agonising from European officialdom, while China worried about its stash of US paper. Yet the dollar’s dominance increased in subsequent years, particularly in the last decade when aggregate reserves levelled off but the private sector made heavy use of the currency in international transactions.
The dollar’s global role will most likely ease in the coming years as portfolios are rebalanced somewhat away from the currency in reaction to Trump’s policies and the associated diminished confidence in the US. That will hurt Americans and the international community. But ‘sell America’ concerns and the news of the dollar’s demise are premature.
Mark Sobel is US Chair of OMFIF.
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