18 February 2025 - 1:00pm
Something strange is happening in world markets.
Conventional economic theory presumes that US tariffs will strengthen the dollar. If American traders judge their customers will substitute local for imported goods, they’ll demand less foreign currency, reducing its value against the greenback. However, the flurry of tariff announcements since Donald Trump took office last month has apparently had the opposite effect, and is weakening the dollar.
In itself this isn’t cause for alarm. Indeed, by making imports more expensive it could help the President to meet his goal of reducing the trade deficit, thereby providing short-term benefits to the US economy.
But there is some concern as to what is driving this decline, because it may actually be a symptom of a deeper malaise. The weakening dollar overlaps both with a continuing rally in the price of gold, which is now setting all-time highs, and with the rotation out of US assets, as the dynamism in world stock markets shifts from the US to Europe, Asia and elsewhere. The gold rally is driven both by central bank and retail buying, while the rotation out of the US market is apparently being undertaken by foreign investors repatriating money. But taken together, it seems to indicate that the world is starting to hedge against the possibility the US will turn permanently inwards.
These are subtle shifts which time may reveal to be purely cyclical. Were, say, Donald Trump to roll back his tariffs, investors might well return to the US. Indeed, the expected hit from tariffs to both corporate profits and the economy as a whole has not produced major falls in US share prices, suggesting that investors have already concluded that Trump won’t follow through on his threats.
All the same, the value of the dollar merits watching, because it’s possible a structural change is beginning. Although the US’s share of global trade is less than its share of global output, the country remains central to the world economy because it is its biggest importer. It’s able to run a chronic trade deficit because everyone else is willing to take IOUs, which they then treat as cash — essentially, the US credits the accounts of foreign governments on the implicit understanding the US will one day come good on its debts. Since nobody calls in the debts, the world economy can keep humming on the credit extended to the US.
Put simply, the stability of the world economy rests on a shared understanding: the world lends the US money to buy its goods. That loaned money is then invested in the US economy, in stocks, bonds and real estate, pushing asset values up and interest rates down, giving Americans the financial wherewithal to keep buying.
In his determination to reduce the trade deficit, though, Donald Trump threatens to upend this arrangement. If their US reserves drop, foreigners will have less to invest in the US. Not only could this potentially slow the US economy, but it could reduce the growth of the global dollar supply. Were America to turn inward permanently, its status as the keeper of the global reserve currency could one day even come into doubt.
If it’s this possibility for which forward-looking fund managers and central banks are preparing, then what’s happening right now to the dollar may be an early warning of what’s to come. For the foreseeable future, lacking any serious rival, the US dollar will remain the global reserve currency. But it may just be that we’re in the earliest stages of an epochal change in the world economy, as investors start contemplating radically different futures.
John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a Religion (Simon & Schuster, 2017).
jarapley