The end of US dollar dominance

Why Donald Trump’s policies could hasten the dollar’s relegation from being the only world currency

COMMENT | DAVID MCMILLAN | Donald Trump’s victory in November’s U.S. presidential election saw the U.S. dollar strengthen. It surged to a one-year high within two weeks, and has since retained its strength against its major peers. His election has also again brought the prospect of U.S. tariffs on imports, and attention has focused on the disruption to global trade that these may bring.

As part of this, Trump made a not-so-veiled threat of steep levies on the Brics group of leading emerging markets should they create a rival to the U.S. dollar, which has been the world’s “dominant currency” since the Second World War.

The use and holding of the U.S. dollar by other countries is known as dollarisation. It has different levels of meaning, from countries like Panama using the U.S. dollar as their currency, to its use in the pricing of major internationally traded commodities, and as a reserve and vehicle currency. This latter role enhances global trade.

Take Chile and Malaysia as an example. Any trade between these two countries will involve the exchange of Chilean pesos for Malaysian ringgit, for which there is not a large and active market. So, pesos are instead exchanged for U.S. dollars and U.S. dollars for ringgit, allowing trade to occur in a quicker and more cost-efficient manner.

Indeed, the US dollar is used in more than 50% of foreign trade invoices, and over 80% of all foreign exchange transactions worldwide. However, it is possible that Trump’s “America First” foreign policy could serve to hasten the end of the U.S. dollar’s dominance.

Dollarisation is beneficial for global trade. But it brings particular benefits to the U.S, as other countries need to hold U.S. dollars to facilitate trade and pay for many commodities. This means that demand for the U.S. dollar remains high, so it does not come under pressure to depreciate.

A more important point is perhaps that when countries buy U.S. dollars, they don’t hold them in cash. Rather, they buy U.S. Treasury bills and so, in effect, lend money to the U.S. government. This high demand for U.S. Treasuries means the U.S. government is able borrow at a cheaper rate than would otherwise be possible.

However, there are also drawbacks. A strong U.S. dollar increases the price of dollar-denominated commodities and thus the cost of international trade. And for the U.S. itself, a strong US dollar can damage its domestic export business.

These drawbacks have often led to the suggestion of a multi-currency global system, although this has never gained traction or been a serious consideration. But that could change with a second Trump presidency.

During his first term, such calls grew louder. And there have been some shifts in U.S. dollar holdings since then, to the extent that global U.S. dollar reserves have declined.

So, which Trump policies could hasten the end of US dollar dominance? The incoming president is regarded as pro-business, which will probably translate into policies aimed at lowering regulation and taxes. Stimulating domestic growth will lead to an even stronger U.S. dollar at a time when global output is more modest.

A stronger U.S. dollar, as mentioned above, also increases the price of oil and similar commodities. Countries will inevitably ask themselves why oil from Saudi Arabia, for example, should be paid for in U.S. dollars as those dollars become more expensive.

Trump’s economic policies are likely to increase U.S. debt, and this can reduce the value of the large U.S. dollar reserves held around the world. According to one study, Trump’s plans could add as much as US$15 trillion (£11.7 trillion) to the nation’s debt over a decade. A fall in the value of U.S. dollar reserves may result in some countries being less willing to hold U.S. debt.

The effect of these policies might be considered unintentional. But other policies, such as Trump’s plan for higher tariffs, are more deliberately designed.

A strong U.S. dollar damages U.S. exports, as they become relatively expensive in local currency terms, and makes imports relatively cheap. Tariffs are a way to protect domestic producers from this international competition.

However, assuming no other country retaliates, raising tariffs will serve only to further strengthen the U.S. dollar, as fewer imports will mean less U.S. dollars being sold in the foreign exchange market. This will, at least in part, undo the effect of the tariff policy while imposing trade costs globally.

To avoid elements of this, countries could agree to use alternatives as a reserve currency and a means to pay for international commodities. The Brics nations have mooted a separate currency, which could revolve around one or more existing currencies like the Euro or Yuan. Trump’s threats may simply speed up this search for an alternative.

Countries would then need to hold less U.S. dollars, so would sell off their U.S. Treasuries. The result will be a rise in the cost of debt for the U.S., and a fall in the value of the U.S. dollar. Ironically, this would increase the price of imports (the goal of Trump’s tariff policy), but it could also lead to inflation.

In a worst-case scenario, should countries coordinate their selling of U.S. dollars and Treasuries, a run on the U.S. dollar would have major implications for the U.S. and the world. This would lead to higher debt costs in the U.S. and a need to reduce its trade deficit.

Globally, it would disrupt trade, raise transaction costs, and there would be a loss of value for any dollar-denominated assets and reserves. This would most likely culminate in a significant global recession.

The U.S. dollar will remain a global currency for the foreseeable future. But Trump’s “America First” policy, as well as the greater weaponisation of the U.S. dollar, could lead to its relegation from being the only world currency.

*****

David McMillan is Professor in Finance, University of Stirling

Source: The Conversation