It is unprecedented that the dollar is facing such a significant threat. Notably, the primary challenge to U.S. currency currently stems from Donald Trump and his administration's policies aimed at significant trade deficit reduction, coupled with a notable escalation in tariff wars. The forecast remains uncertain: will it be a light rain or a long financial storm?
The Phantom Menace
Unfortunately, the dollar is actually losing ground. The dollar has depreciated by 13 percent since Trump's return to the White House, and this process is ongoing. This will result in a reduction in the U.S. budget in real terms that will soon be felt by every American. Moody's has downgraded the U.S. credit rating from AAA to AA1, indicating concerns regarding the size of the national debt.
As JP Morgan and UBS note, "de-dollarization" is among the most common requests these banks receive from their clients. A growing number of employees of major financial groups and brokerage firms, including Rabobank, Deutsche Bank, and Pepperstone, are warning of the negative consequences of Trump's policies for the US dollar. Consequently, clients are expressing an increased interest in diversifying the risks associated with US currency.
But the good news is, that the process is not yet complete. If implemented effectively, the policies of the current administration could potentially address the significant national debt issue and alleviate its impact on the economy. American companies have started to borrow more actively in Europe, providing additional capital inflows. This is a short-term stimulus that instills hope that minimal losses can be sustained.
Central banks are no longer placing 100% faith in the dollar
Concurrently, the erosion of confidence in the US dollar has now spread to the central banks of many countries worldwide, which are generally unaffected by the political situation. The share of dollar assets in central bank reserves has reached its lowest point in the last twenty years, and foreign ownership of U.S. government bonds has been decreasing for the last fifteen years.
European Central Bank officials, along with EU financial supervisors, have started to raise concerns about the Federal Reserve's capacity to maintain financial stability during a significant crisis. The scenario of a failed outcome of the U.S. administration's political pressure on the regulator is seen by the Europeans as highly realistic. In such a case, Washington may use access to dollar liquidity as a tool of pressure on partners, similar to the use of trade tariffs. This possibility is not excluded, as it is referenced by Reuters.
The ongoing uncertainty surrounding the U.S. financial outlook under Trump has led to a decline in confidence in the dollar as an international reserve currency. Are there any additional measures that can be taken, or is the opportunity for intervention no longer viable?
Something new is needed
Key officials in the Trump administration's economic bloc, including presidential adviser Peter Navarro and the head of the economic advisory group Stephen Miran, argue that the world is on the brink of a shift in international trade and finance. They claim that existing systems, in their current form, have damaged the American economy and must be reformed.
At the same time, the dollar's established role as the world's reserve currency imposes significant financial costs on the United States, negatively affecting the real sector of the economy. The U.S. currency is overvalued, and the country needs urgent measures to protect and restore production for security reasons.
According to the White House, lowering the international use of the dollar requires applying tariffs to countries with significant dollar assets. The goal is to increase the value of their currencies relative to the dollar. This strategy is reminiscent of the "Plaza Hotel Agreement," which Washington signed with key trading partners in 1985. Then, under the threat of tariffs, U.S. counterparts voluntarily agreed to strengthen their national currencies against the dollar, consequently losing export competitiveness.
However, today the situation is different. Washington's power has little effect on China, which holds the main trade surplus with the US. Consequently, Trump's "Mar-a-Lago Agreement," which aims to strengthen key world currencies against the dollar, is unlikely to have the same effect as the "Plaza Agreement."
Instead, Trump's tariffs are pushing China, India, and other emerging economies to seek closer ties outside of Washington's financial sphere of influence. This, in turn, fuels these countries' desire for de-dollarization, which has already resulted in reduced use of the dollar for currency transfers.
This sets a dangerous precedent that could lead to other countries refusing to peg their financial and foreign trade transactions to the dollar. It seems that Beijing has enough power to start this process, which will be difficult for Washington to stop.
