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The writer is the author of ‘Two Hundred Years of Muddling Through: The Surprising Story of the British Economy’
One common thread running through the 2025 year ahead outlooks from banks and asset managers was a near-consensus view that the dollar would strengthen further in the coming 12 months. Like much else in the incoming Trump administration’s agenda, the talk around the value of the greenback has been at times contradictory.
Donald Trump himself, together with many of his key trade policy advisers, has long argued that a strong dollar has made American exports pricey, encouraged imports and cost American manufacturing jobs. Others appointed to key jobs, though, such as Scott Bessent, nominated for the post of Treasury Secretary, have publicly taken a more traditional stance and supported a strong dollar.
Whatever the new administration might desire, the markets seem reasonably certain that the result will be a stronger dollar rather than a weaker one. The dollar has risen by around 8 per cent since late September when investors began to price in a rising likelihood of a Trump victory in November. A stronger dollar has been a key component of the Trump trade which gripped Wall Street last year. Broadly put, the Trump trade is an assumption that the new president will follow through on all the aspects of his agenda which markets approve of, while being restrained by his wider party from anything they are less keen on.
Tax cuts and deregulation will boost profits and equity market returns while the resulting higher deficits will be bad, but not disastrous, for US Treasuries. Markets expect the yield on American government bonds to rise relative to a no-Trump counterfactual but implicitly assume that the rise will not be enough to rattle the stock market. A rising interest rate differential with other advanced economies though will, by the logic of the Trump trade, be enough to push the dollar higher. The threat of higher tariffs, which would result in fewer dollars leaving America, has added to the dollar’s lustre since November.
The consensus view, then, is that the dollar will remain strong even if the new president occasionally takes to social media to loudly groan about it. There are, though, at least three reasons to worry that this consensus is complacent.
Tariffs are the first. Economic theory suggests that in the short-run new tariffs can indeed lead to a strengthening currency. The currency of the trading partner subject to new restrictions often depreciates to offset, at least partially, the value of the tariffs. This was broadly the case with China’s renminbi in 2018-19. But in the longer run tariffs are associated with fewer imports and exports and an overall weaker economy. That weakness eventually leads to lower interest rates and hence a weaker currency. Tariffs might give the dollar a short-term fillip but weaken it in the medium to longer run.
Secondly, it is worth taking seriously the notion that when Trump says he wants a weaker dollar, he actually means it. The threat of much higher tariffs on America’s major trading partners could well prove to be merely the opening gambit in an attempt to corral those trading partners into some form of multilateral agreement to lower the dollar’s value. There can be little doubt that the author of The Art of The Deal would not delight in hosting a summit at Mar-a-Lago to preside over negotiations. Of course, the mechanics of such a deal would prove tricky. The Plaza Accord of 1985, at which the finance ministers of the US, the UK, West Germany, France and Japan met to discuss international exchange rates, is sometimes held up as a model. But the world economy is a very different place nowadays. The five participants 40 years ago represented around 45 per cent of global GDP, at purchasing power parity, between them compared with more like 25 per cent today.
The other major threat to the dollar’s value can be found outside the traditional realm of economic policy. Work by the economists Barry Eichengreen, Arnaud Mehl and Livia Chitu in 2017 examined the geopolitical underpinnings of international currency values. In general, countries hold a greater share of their reserves in the currency of a country providing them with a security guarantee. By this argument the US’s provision of security to its allies helps to hold up the value of the dollar and keeps US borrowing costs lower than they would otherwise be. If those security guarantees start to be unwound, then the dollar’s share in international reserves could begin to fall, providing a further headwind.
The dollar has had a strong run since September but many of the views underpinning those gains may prove to be wishful thinking.
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