The dollar - past, present, future

The dollar - past, present, future

Recent weakness in financial markets has been accompanied by a sell-off in the US dollar. Along with a sell-off in equities and bonds, the dollar has fallen to its lowest level since 2022, down over 9% against a basket of currencies since the start of the year.

• This inverts the usual relationship in which investors move into dollars in times of elevated risk. America’s vast economy, backed by strong institutions and stable government, has long been seen as a safe haven in times of elevated risk. Yet recent uncertainties, triggered by shifts in US trade policy have seen investors shun the dollar and flock to other currencies, including the Swiss franc and the Japanese yen. Yesterday’s further sell-off in US equities and the dollar came in the wake of a social media post from Donald Trump calling on the Federal Reserve to cut interest rates immediately. The Fed has significant operational independence, including over interest rates, and such interventions are highly unusual.

• Under current plans US tariffs are set to rise to the highest level since the 1930s, more than ten times higher than at the start of this year. This is arguably the most momentous break in US economic policy since America’s abandonment of gold convertibility in 1971. The current US administration’s departure from the free trade consensus of the last 80 years has prompted speculation about previously unthinkable outcomes, such as selective treasury defaults or the withdrawal of federal dollar swap lines to allies.

• The sell-off in the dollar, shifts in US trade policy and speculation about even more radical policies – all raise the question of whether the dollar’s position as the world’s reserve currency, a position it has held since at least 1945, could be threatened.

• Reserve currencies are held in significant quantities by other central banks as part of their reserves – which can be used if necessary to buy imports, meet international debt obligations or influence the domestic exchange rate. Currencies held by central banks tend to be those most widely used in international trade and finance. The essential characteristics of a reserve currency is that it is convertible, backed by credible economic policies and has scale. For at least 80 years no country has come close to matching the US dollar on these criteria – and as the dominant reserve currency. 

• The US accounts for about a quarter of global GDP yet close to 60% of the world’s official foreign currency reserves are in dollars. The dollar is involved in 88% of all foreign exchange transactions. 70% of international bond issuance, 60% of all international loans and deposits and over half of all trade are denominated in dollars.

• Critics contend that the dollar gives the US an outsize influence in the world and provides the US government with cheap credit because foreign demand for Treasuries drives down borrowing costs. In the 1960s, France’s then minister of finance, Valéry Giscard d'Estaing, famously claimed that the dollar gave America an “exorbitant privilege”. The phrase has stuck.

• America certainly benefits from the dollar’s role as a reserve currency, but the size of these benefits is contested and they are not without costs. In a recent paper for the American Enterprise Institute by two former US policymakers, Steven Kamin and Mark Sobel, argued that the economic benefits of dollar dominance for the US were unlikely to be huge nor are the costs imposed on trading partners likely to be significant (AEI Economics Working Paper 2024-02, January 2024). For Kamin and Sobel the dollar’s greatest value to the US lies in geopolitical, not economic sphere, and the ability it gives the US to sanction ‘bad actors’ around the world.

• By facilitating global trade and commerce the dollar has created large net benefits for the rest of the world. The globalisation and economic growth of post-war period have been built on dollar stability. It is hard to see how any other currency could have fulfilled this role – no other currency has the credibility, the scale, in terms of domestic debt issuance and the convertibility of the dollar. Private cryptocurrencies, which are sometimes touted as a reserve currency, are currently too volatile, illiquid and poorly regulated to do the job. 

• A potential disadvantage for the US of the dollar’s global role is that it creates excess demand for dollars, artificially inflating its value. Again, the precise effects are contested. But last year Mr Trump took up the theme, saying a strong dollar had been a “tremendous burden” on US industry. Before he became head of Mr Trump’s Council of Economic Advisers, Steven Miran, last year wrote a paper arguing that the US should seek to weaken the dollar to counter the effects of supposed overvaluation caused by its reserve currency status (Mr Miran has since distanced himself from these conclusions and said that the paper does not represent the position of the administration).

• The central question is whether the dollar’s global status is good for the US. That has certainly been the view of successive generations of US politicians and policymakers. At the Bretton Woods Conference in 1944 American negotiators set out to supplant sterling as the dominant world currency. They succeeded, and subsequent US administrations held to the view that the dollar’s global role is a strategic asset. The current administration has not suggested that it takes a different position. But uncertainty about economic policy and the administration’s wider aims, especially, in relation to trade, have reopened a familiar question about the role of the dollar.

• The dollar is fundamental to the operation of the global economy and has been for many decades. The absence of any real contender for the role of global reserve currency means that dollar dominance looks as if it has much further to run. Yet while it may lack competition, the dollar is not unassailable.

• Confidence in US policy and institutions is what gives the dollar its power. The sell-off in the dollar suggests a lack of confidence. This is not about external challenges to the US. As Kamin and Sobel conclude, “The United States is ultimately the biggest threat to global dollar dominance.”

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 3.9% at 8,276 as temporary US import tariff exemptions for consumer electronics boosted investor sentiment. 

 Economics

• In a post on Truth Social yesterday, Donald Trump called on Jerome Powell, chairman of the Federal Reserve, whom he called “Mr Too Late”, to lower interest rates “NOW” to stimulate the economy
• The S&P 500 index fell 2.6% yesterday, the gold price hit record highs and the US dollar fell by almost 1%
• US companies with low credit ratings have been unable to sell corporate bonds in recent weeks as recent economic uncertainty has reduced investor appetite for riskier deals, the FT reports
• OPEC revised down its forecast for oil demand in 2025 and 2026 due to weaker expectations for global growth 
• UK inflation softened more than expected to 2.6% in the year to March, down from 2.8% in February, mainly due to lower petrol prices. Markets expect the Bank of England to cut interest rates in May
• UK business confidence fell to its lowest level since the end of 2022, according to the Institute of Chartered Accountants in England and Wales, attributed to global trade uncertainty and higher employer national insurance contributions
• The European Central Bank cut the benchmark interest rate to its lowest level since 2022, to 2.25%. The ECB noted that “the outlook for growth has deteriorated owing to rising trade tensions”
• German economic sentiment fell in April at its fastest rate since 2022 amid recent uncertainty surrounding global trade, according to ZEW
• Chinese GDP increased 5.4% in the first quarter of 2025 compared with the same period last year, exceeding expectations as producers brought forward exports ahead of rising US tariffs on Chinese goods

Business

• The UK government passed a law enabling it to take control of British Steel’s steel production site in Scunthorpe and purchase the raw materials required to maintain its operation
• The UK government said it would “look at a Chinese firm in a different way” when it considers future investment in the “sensitive” steel sector
• Chief executives of electrical goods retailers said that there are early signs of Chinese firms ‘dumping’ products across European markets via e-commerce platforms as they reroute goods from the US to avoid tariffs
• Technology company Sony said that it will increase the price of its PlayStation 5 gaming console globally, including by 10% in the UK, following US tariffs announcements and fluctuating exchange rates
• Luxury fashion brand Hermès announced future price rises in the US to counter higher US import tariffs
• US president Donald Trump announced a freeze to Harvard University’s $2.2bn government funding and threatened to scrap its tax-exempt status following rising tensions between the Trump administration and elite US universities
• US semiconductor manufacturer Nvidia said that it expected to take a $5.5bn hit to earnings in the three months to April because of new export restrictions on its ability to sell chips to Chinese organisations
• Demand for London office space increased 39% in the first quarter of this year compared with the previous quarter, according to estate agent Knight Frank, in part due to the increasing return-to-office trend
• US private equity firm Atlas announced a £236m takeover of UK banknote printer De La Rue

Global and political developments

• US vice president JD Vance said that there is a “good chance” of a US-UK trade deal. Trade talks are currently ongoing
• The FT reported that in recent weeks Chinese state-backed investment funds have been pulling back from investing in the funds of US-headquartered private capital firms
• UK members of parliament said that the government should review Chinese investment in UK critical national infrastructure following the government’s intervention in the operations of British Steel
• A migrant returns pilot scheme between the UK and France to return migrants is currently under discussion 
• The US House of Representatives China committee is questioning how Chinese company DeepSeek obtained and used US export-controlled chips, produced by US technology company Nvidia, to power its artificial intelligence app
• The US has imposed sanctions on a Chinese oil refinery in response to their purchasing of more than $1bn worth of Iranian crude oil, the latest action of increased US pressure against Iran

And finally… around 300 residents of a local community in Michigan formed a human chain to help a bookshop move to a new premises one block away. Locals managed to move over 9,100 books in under two hours, even ensuring the books were transported to the correct shelves – bookworm