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Donald Trump, US President-elect and self-proclaimed “tariff man”, will be back in the White House in late January.
On the campaign trail, President-elect Trump said he planned on implementing tariffs of 60% on China, 10% on the rest of the world and much higher tariffs on specific sectors and countries, such as autos coming from Mexico. He and his soon-to-be Vice President, J.D. Vance, have also highlighted that a key objective will be to weaken the US dollar, without undermining its reserve status, to aid US competitiveness. The dilemma here is that higher US tariffs should lead to a strong US dollar, all else being equal, under floating exchange rates – as was the case during the tariff period of 2018-2019.
More broadly, advisors to the President-elect view this prior period as a success. They believe that the rise in tariffs was broadly offset by US dollar appreciation, resulting in a limited domestic inflation impact, but a notable pick-up in revenue for the US Treasury. And because Chinese purchasing power declined, through currency weakness, China effectively paid for the tariffs. US equity market performance – a key measure of success for Trump during his prior term – also only weakened briefly before bouncing back strongly. Such a view likely emboldens his team for round two, but how can a weaker US dollar be achieved this time when it wasn’t before, and what might the implications be?
The US dollar’s status as a reserve currency gives the US significant influence over the global economy through financial transactions and trade. This status is believed to have several significant implications: 1. the dollar is persistently overvalued due to price-insensitive demand for the currency to be held as reserves and for trade; 2. the US must run a persistent trade balance deficit to supply the world with dollars under the Triffin dilemma1 and 3. the US government has the ‘exorbitant privilege’ of borrowing at cheaper rates than it otherwise could. Trump would, at a minimum, like to moderate and begin to reverse the first two points, which have posed significant headwinds for US manufacturing and industry, while broadly maintaining the third.
Based on round one of tariffs during his last term, it’s likely that Trump will present a long list of demands to trade partners, incrementally turning up the heat by ratcheting tariffs higher until they make concessions. If tariffs are to be used as leverage, then one demand could be to seek multilateral co-ordination, particularly between the US, China, Japan and the eurozone, to weaken the dollar – effectively a Plaza Accord 2.0.
If achieved, such action would cheapen the US dollar and improve US trade dynamics – but what about the exorbitant privilege if reserve managers are required to sell their dollars (US Treasuries) to buy their own currencies? One solution would be for the US administration to specify that although countries would be required to reduce their reserves in total, placing upward pressure on US yields, they would be required to term the remainder of the dollar reserve holdings out to mitigate upward pressure on longer-dated yields. Therefore, maintaining the exorbitant privilege. Once multilateral co-ordination is achieved to weaken the dollar notably, the US administration could then row back on tariffs to some extent.
So, in our view, it does appear possible to achieve higher tariffs and a weaker US dollar – both of which would go some way to help the Trump Administration achieve its goals – but it is an understatement to say that there are a lot of moving parts here. In such a scenario we would likely first see ongoing US dollar strength and broader US exceptionalism (US equities outperforming). This would likely be followed by a phase of sustained dollar weakness, which could lead to reflexive benefits for global manufacturing, trade and risk asset performance. The risk case here is, of course, that concessions are not made by trading partners, and tariffs are ratcheted higher until they eventually undermine global trade with a negative feedback loop into growth and risk asset more broadly.
We maintain an open mind and await clarity on which path will ultimately unfold.
1 The Triffin Dilemma, an economic paradox identified by economist Robert Triffin, highlights the conflict faced by a country that issues the global reserve currency: balancing the need for sufficient global liquidity (often requiring trade deficits) with maintaining the currency’s long-term stability.
