- The dollar has welcomed the red sweep in this month’s US elections
- Trump’s tariff plans are seen as good for the US trade deficit and thus the currency
- According to the Triffin Dilemma, a strong dollar could have unintended consequences given its status as the globe’s reserve currency
“The US government bond market does not seem quite sure what to make of the prospect of a second Trump presidency, but the US stock market seems happy and so does the US dollar, using the trade-weighted DXY (or ‘Dixie’) index as a guide,” says AJ Bell investment director Russ Mould. “The buck is breaking out to a one-year high, but sustained strength in the greenback could leave financial markets, and potentially the president-elect, on the horns of a dilemma – the Triffin Dilemma, in fact.
Source: LSEG Refinitiv data
“The current world monetary system was set up in 1971, when then US president Richard M. Nixon and Treasury secretary John Connally took America off the gold standard, effectively killing the Bretton Woods system set up toward the end of the Second World War. Bretton Woods had replaced the pound with the dollar as the globe’s reserve currency, pegging other currencies to the US currency and in turn to gold, for which they could exchange greenbacks.
“The idea was that America, the world’s economic superpower, could not easily run a cheap dollar policy and export its way to total dominance or be fiscally imprudent at home. A soaring gold price (or tumbling dollar) would be the sign than the US was printing – and devaluing – dollars.
“Professor Robert Triffin spotted the catch in a book he wrote in 1960, Gold and the Dollar Crisis: The Future of Convertibility. He argued that the greenback’s global reserve currency status would come at a cost – either to America or the world.
“The current system is all well and good while confidence in the dollar remains, lenders are happy to hold US Treasuries and the US is happy to run a trade deficit. But it becomes a problem if lenders lose faith (as they did briefly in 2008) or America’s trade policy is changed.
“This is where president-elect Trump enters the equation.
“America’s last trade surplus was 1975, according to the US Bureau of Economic Analysis, and Trump’s first administration made little or no dent in the annual trade deficit.
“If he succeeds this time around, and America sells more than it buys, dollars will flow back to the USA and drain the global economy and the world’s financial markets of the greenbacks and liquidity upon which they are reliant.
Source: FRED - St. Louis Federal Reserve, database, US Bureau of Economic Analysis
“It may be that this issue does not arise. With the possible exception of China, much of Trump’s tariff talk could be just that – talk – as he adopts a bargaining position in search of a deal.
“Moreover, the president-elect has yet to make any particular comment on the currency. But rhetoric during his previous presidency, and also comments from vice-president elect J.D. Vance in the 2024 campaign, suggest he prefers a weak dollar as a means of boosting exports.
“In addition, Trump spent his first spell in the White House badgering the US Federal Reserve for interest rate cuts, and looser monetary policy could also weaken the dollar, at least if the Fed lowers headline borrowing costs either faster than expected or faster than its global peers.
“Only time will tell, but if Trump does impose tariffs, the US trade deficit shrivels, and the dollar remains firm then there could be some unintended consequences.
“Commodity prices generally struggle under a strong dollar and so do emerging markets, the former because a higher greenback increases the cost of raw materials for non-dollar users and the latter because their dollar-denominated debts become heavier and more expensive to service. In short, a strong dollar is inherently disinflationary, even deflationary for the world.
Source: LSEG Refinitiv data
Source: LSEG Refinitiv data
“This is the potential no-win scenario that faces the new Trump administration.
“His policies are designed to boost US economic exports, output and growth. But if they prove so successful that the dollar advances strongly as a result, then the damage to the rest of the world could be considerable and perhaps enough to deprive America of the buyers of its exports for which it longs.
“Again, it may be that the threat of across-the-board tariffs on US imports is no more than a bargaining tool, but investors will need to watch the trade-weighted dollar (DXY) index, any comments from the president-elect on US Federal Reserve policy and the gold price for clues as to what may be coming next.
“The precious metal may be the biggest ‘tell’ of all. If Trump fails – or backs off – and the US keeps piling up a fiscal deficit as well as a trade one then gold could thrive, not least as such an environment would smack of plentiful dollar supply and greenback weakness (especially if the Fed resorts to lower interest rates, or even a return to Quantitative Easing, to keep the national debt and associated interest bill manageable). If he succeeds, renewed faith in paper dollars would perhaps lessen even gold bugs’ ardour for the precious metal as a store of value.”
Source: LSEG Refinitiv data
