Trump’s game plan for devaluing the mighty dollar

 Economic orthodoxies are being challenged left, right and centre under Donald Trump’s second presidency.

Disallowed from running for a third term, and therefore free of the normal constraints of having to face the ballot box anew, he behaves like a man possessed.

What comes next? It’s hard to know, but one policy objective which has so far received only passing attention is a seeming determination to weaken the dollar.

On the face of it, this might seem an odd objective for Trump’s wider, Make America Great Again (Maga) agenda, and to be fair, it’s not Trump himself who advocates it publicly, but a number of prominent figures in his administration.

A strong dollar has long been a touchstone of US economic policy. It helps keep inflation low, it encourages foreign investment in the US, and it supports the dollar’s role as the dominant global reserve currency.

What’s more, it is widely seen both domestically and internationally as symbolic of US economic strength and a badge of continued hegemony.

So why would Trump want to mess with such an asset, particularly when the dollar’s importance at the heart of the world’s financial system is so easily weaponised for geopolitical purposes?

No other country commands the financial power abroad that the US enjoys through the mighty dollar. Valéry Giscard d’Estaing, a one-time French president, called it America’s “exorbitant privilege”.

I imagine this is not an attribute that Trump would want to dispense with. But the Maga toolbox is a mass of contradictions, and the fact is that measures to weaken the dollar follow logically from the president’s wider pursuit of protectionist trade policy.

This is because increased tariffs typically put upward pressure on the currency of the country enacting them, and downward pressure on the currencies of those they target.

All other things being equal, tariffs will raise domestic US inflation, and therefore push interest rates higher. The same goes for much of the rest of Trump’s economic agenda, which via unfunded tax cuts promises to be strongly stimulative.

If, conversely, the recession that some are warning of materialises, then interest rates would fall. But this would not necessarily ease the upward pressures on the dollar, which because of its reserve currency status enjoys safe haven attractions even when the going gets tough.

In any case, a strengthening dollar would at least partially offset any competitive advantage that tariffs bestow on American producers, and would therefore undermine Trump’s main goal of re-engineering the US economy as a reborn, manufacturing power house.

There’s nothing new under the sun, so it won’t surprise you to know that we’ve been here before. Rewind to the mid-1980s, when Ronald Reagan was the US president, and America was cursed by a similarly large trade deficit, and thanks to the administration’s expansionary fiscal policies, a relatively strong currency buoyed by high interest rates.

Under threat of tariffs, the US’s four largest trading partners at the time – Japan, Germany, France and the UK – were persuaded to intervene in currency markets to weaken the dollar, an agreement that became known as the Plaza Accord.

It worked; from peak to trough, the dollar lost about 40pc of its trade weighted value. That success has galvanised calls from some in the Trump administration for a sequel, already dubbed for obvious reasons the “Mar-a-Lago Accord”.

Yet the world is a very different place today, not least because of the arrival of another 10-ton gorilla on the global stage in the shape of the People’s Republic of China.

In a world where even allies are turning on each other, the necessary consensus for Plaza 2.0 would be hard to impossible to achieve.

To be sustainable, moreover, would require the US to run artificially low interest rates and everywhere else to run them high. This would be doubly inflationary in the US and is scarcely likely to appeal to either Europe or China, where economic conditions are currently weak.

Alternatively, countries could be strong-armed into submission. Stephen Miran, who was confirmed last week as chairman of the US council of economic advisers, suggests that surplus countries should be forced to peg their currencies against the dollar at a beneficial rate to the US by threatening them with even higher trade tariffs should they refuse.

Yet even if this form of competitive devaluation via blackmail were initially successful, it wouldn’t necessarily stop the flow of foreign capital into US markets, and would therefore be hard to maintain.

Miran has got an answer for that, which is to tax the coupon on US treasury securities for overseas buyers so as to discourage foreign demand for them.

The same effect could be achieved, Miran argued in a paper last November, by forcing countries to swap their holdings of US Treasuries for 100-year bonds. In return they would receive security guarantees.

It scarcely needs saying that both these lines of attack would be regarded as a default, and would therefore play havoc with US debt markets and the federal government’s ability to fund its burgeoning budget deficit.

A further approach would be to require the US Federal Reserve to sell dollars for foreign currency without limit, though where that would leave the US’s domestic monetary system is anyone’s guess.

These are by no means fringe views in the Trump camp. Scott Bessent, the US treasury secretary, has separately pushed the idea of some kind of Bretton Woods-style realignment of global currencies that would put US producers at less of a competitive disadvantage.

The US is by far the biggest buyer of goods in the world; it’s about time, Bessent’s aides say, that the rest of the world started treating the US with the same respect that a business would reserve for its largest customer, and stop ripping Americans off.

As last week drew to a close, Trump’s trade war showed every sign of spiralling out of control. Both the European Union and Canada are seemingly up for a fight, with tit-for-tat retaliatory action against anything Trump throws at them.

As I say, there is nothing new in today’s world that hasn’t been seen before. The whole ghastly, divisive mess we see unfolding before us was perfectly foreseen by the British economist John Maynard Keynes, and is in a sense a direct consequence of the dollar’s global reserve currency status.

Without going into the precise mechanisms, this in effect requires the US to run big, compensating fiscal and trade deficits so as to supply the rest of the world with the dollars it demands.

Keynes’s solution was to establish a separate international reserve currency which he called the “bancor”, but it never flew.

And in any case, would Trump really want to give up the dollar’s “exorbitant privilege”? It’s a fair bet that he would not. Nor does he seem minded to run the balanced budgets that would help mitigate the trade deficit.