By Joseph Adinolfi
Markets ultimately determine exchange rates – and a weaker dollar might come with unwanted consequences
By picking J.D. Vance as his running mate, former President Donald Trump has sent an unmistakable signal that, should he return to the White House in January, weakening the U.S. dollar would be a policy priority.
Both men have expressed skepticism about the economic benefits of a strong dollar. Instead, they see it as an obstacle to a revival of U.S. manufacturing, which has become central to both of their political identities.
However, some economic-policy experts expressed concerns that trying to deliberately undermine the dollar could come with substantial risks. Perhaps the biggest would be diminishing the dollar’s status as the world’s reserve currency.
But there are other potential drawbacks as well.
Be careful what you wish for
Having the dollar as the de facto global currency has come with considerable benefits for the U.S., including allowing the government to borrow at lower interest rates.
It has helped boost Americans’ standard of living by lowering the cost of imported goods, while amplifying Washington’s ability to project U.S. dominance on the world stage, said Mark Sobel, who served at the Treasury Department for nearly four decades, including as deputy assistant secretary for international monetary and financial policy from 2000 to early 2015.
“Basically, the dollar is the reserve currency of the world not because we declared it as such, but because we have a huge economy, we have the deepest, most liquid capital markets in the world and we have a history of relatively decent macroeconomic policy,” Sobel said.
“People trust the U.S. as a global leader. You could get the dollar down by harming those foundations, but that would be tantamount to the U.S. shooting itself in the foot.”
Vance has questioned whether this is actually the case, arguing during a Senate hearing last year that the drawbacks of the dollar’s reserve status might actually outweigh its benefits.
Trump, on the other hand, has compared losing the dollar’s reserve status to “losing a war” and the 2024 Republican Party platform calls for keeping it.
Still, both Trump and Vance have advocated for a weaker dollar. Trump recently raised the issue again during an interview with Bloomberg Businessweek after the greenback appreciated substantially against the Japanese yen (USDJPY) this year. It has risen against other major currencies as well, although not as dramatically.
There have also been reports that some of Trump’s advisors are exploring avenues to blunt the independence of the Federal Reserve should he win a second term. That would strike at one of the central tenets undergirding the dollar’s reserve status, Sobel has said.
See: A Trump-Vance victory should be bearish for the dollar and Treasurys
The world has been shifting away from the dollar as the sole dominant currency for a while now, based on the composition of foreign-currency reserves held by central banks, but that doesn’t mean the dollar will be replaced any time soon.
“Who exactly would replace us?” said Maurice Obstfeld, a professor of economics at the University of California, Berkeley, and a former chief economist at the International Monetary Fund.
Weaker dollar risks reviving inflation
A revival of inflation or a hit to economic growth are two other potential risks from a weaker dollar. Both seem incompatible with other Trump policy goals.
“If you want to tamp down inflation, but at the same time you want to weaken the dollar, those are probably inconsistent goals,” Obstfeld said during an interview with MarketWatch.
But there are other inconsistencies as well. Raising tariffs on imported goods, one of Trump’s signature economic policies, would also likely result in a stronger, not weaker, dollar as the market adjusts to shifts in demand for foreign currencies relative to the greenback, Obstfeld said.
The same can be said for tax cuts, according to Sobel.
“If there are new tax cuts and extensions, that would put further upward pressure on interest rates,” Sobel said during an interview with MarketWatch. “The dollar tends to rise when interest rates are high and rising.”
A weaker dollar also might not do much to revive American manufacturing, Obstfeld said. The U.S. dollar weakened during the 2000s, but that didn’t prevent a precipitous decline in factory jobs.
IMF says dollar
While the dollar has appreciated substantially against the Japanese yen and, to a lesser extent other currencies, the International Monetary Fund said the change in the currency’s value this year simply reflects changes in interest-rate differentials.
Others say the currency remains overvalued, and there are some data to back this up.
“I think it absolutely is,” Sobel said.
The dollar’s real narrow effective exchange rate, which is monitored by the Bank for International Settlements, stood at 104.83 as of May 1, the latest data available via the St. Louis Federal Reserve’s FRED platform.
That is nearly 12% higher than the long-term average going back to the mid-1960s, according to the gauge, which is updated monthly.
Enlisting help from abroad
Deliberately engineering a weaker dollar would likely require the help of international partners, Obstfeld said. Should Trump return to the White House, he could try to seek assistance from other nations on the currency issue.
There is precedent for this: In 1985, President Ronald Reagan’s Treasury secretary, James Baker III, signed the Plaza Accord alongside representatives from the governments of Japan, the United Kingdom, West Germany and France.
The deal called for coordinated intervention to deliberately weaken the dollar and was ultimately successful.
However, Obstfeld doubts Trump would have an easy time convincing Europe and Japan to agree to a similar deal today, given his tariff proposals and demands that U.S. allies pay more for defense. Both policies angered U.S. allies during Trump’s 2017-21 term in the White House.
“How do you get these countries to cooperate?” Obstfeld said. “Goodwill is going to be in short supply given the kinds of policies a Trump administration would be pushing.”
There is another important implication of a weaker dollar that Trump would need to consider, according to Steve Englander, global head of G-10 foreign-exchange research and North America strategy for Standard Chartered Bank. A strong dollar is seen as a vote of confidence in the U.S. economy.
“A weaker dollar has been associated with a softer U.S. economy,” Englander said during an interview with MarketWatch.
The Trump campaign did not respond to a request for comment.
Expectations that the Federal Reserve could soon start cutting interest rates have recently helped to push back against the dollar’s strength. The ICE U.S. Dollar Index DXY, a gauge of the dollar’s strength against a basket of major currencies, was down 0.3% at 103.75 on Wednesday after earlier touching its weakest level since March.
With more interest rate cuts expected to follow in 2025, letting markets do what comes naturally might be a better option than taking additional steps to deliberately weaken the currency.
-Joseph Adinolfi
This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.
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07-18-24 0726ET
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