By bizn_fun 
Magical thinking is indispensable to understanding Team Trump’s 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.
A heavy dose of hocus pocus will be needed to make the administration’s dollar policy work in the interest of the United States, for it appears that they want to end the US dollar’s supremacy in global finance.
At least some part of it does. True, Donald Trump has warned countries not to replace the dollar, or else. And, reportedly, some members of the administration want to encourage more countries to adopt the dollar outright. But what is also true is that Stephen Miran, the president’s chief economic adviser, on leave to act as board member of the Federal Reserve, thinks the dollar’s 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.
“America runs large current account deficits not because it imports too much,” Miran wrote last year. 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 “persistent dollar overvaluation that prevents the balancing of international trade.”
The quote brings to mind Jenny Holzer’s 1980s Times Square billboard, with its dry appeal to a higher power: “protect me from what I want.”
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.
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’s fragmented capital markets. A quarter century from the euro’s launch there is no euro T-bond. The renminbi, meanwhile, can’t play a leading role in global finance while China retains capital controls that keep money from freely flowing in and out.
The dollar is valuable not only as a financial haven. A recent research paper 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’s currency with the dollar – can help hedge against these economic fluctuations.
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’ access to the financial system. Moreover, the US would relinquish what former French president Valery Giscard d’Estaing called the US’s “exorbitant privilege”.
Miran is not wrong that the dollar’s reserve status draws a lot of money into Treasury bonds. But that is a gift. It allows the government to fund its massive debt – 120% of GDP – at a low interest rate. The privilege also implies that the US earns more 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.
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 or other countries has shrunk over time.
And Trump’s trade war will reduce the dollar’s insurance powers. By curbing US imports, Trump’s tariff wall will dampen the relationship between the dollar and the price of traded goods–reducing its value as a hedge against economic shocks. “We’re 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,” notes Tarek Hassan of Boston University.
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 in recent months, turning to currencies with lower interest rates like the Swiss franc and the renminbi.
The notion that the president’s trade war might undermine the dollar’s pre-eminence struck hard on “Liberation Day” in April when Trump first announced his round-robin “reciprocal” 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’s safe haven, where governments, investors and regular people park money in times of unrest.
Markets have calmed down since then. Investors appear to have forgiven Trump for the incoherent policymaking. Maybe it’s because Trump ultimately walked back many of the tariffs. But blood is in the water. The odds that the Treasury bond will lose its primacy as the world’s safest asset are looking shorter.
Who knows what that would entail? Other currencies might fill some of the slack. Europe’s joint effort to rearm, for instance, could open an opportunity for euro-wide bonds to rival US Treasury bonds in other countries’ foreign exchange reserves. But insurance against economic and financial shocks will likely become more expensive. Global welfare will surely suffer.
Trump & Co might at first applaud a cheaper dollar, which would likely translate into a smaller US trade deficit. The cheers, however, are unlikely to last. This would come, for the US, at an exorbitant cost.