How Trump could make Americans permanently poorer

The immediate costs of President Donald Trump’s trade war are fairly clear. Prices for imported goods are rising while economic growth is slowing. Manufacturers are slashing orders, small businesses with Chinese suppliers are on the brink of insolvency, interest rates are rising, Americans’ retirement savings are bleeding value, and consumers are losing confidence. The severity of these consequences remain to be seen. But even the administration’s defenders concede that Trump’s tariffs will entail some economic pain in the near-term. The real question concerns the long-term impacts of Trump’s misgovernance. The US economy has rebounded from severe shocks twice this century. If neither the 2008 financial crisis nor the Covid pandemic durably reduced America’s living standards, it’s reasonable to suppose that our nation will shake off the effects of Trump’s misrule in due time. Yet there are reasons to fear that his policies will render Americans permanently poorer — at least, relative to the level of prosperity they might have otherwise attained. Trump’s defunding of scientific research threatens to lastingly hinder US innovation, while his discouragement of immigration could constrain long-term economic growth. To many financial analysts, however, the biggest risk is that Trump could permanently reduce the value of the dollar. Currently, the US dollar is the world’s reserve currency — the one used in a majority of the world’s international transactions. To see how this works, consider what happens when a Mexican farmer wants to sell pig meat to a South Korean restaurant chain. The South Korean company probably doesn’t have a ton of pesos in the bank, and the Mexican farmer doesn’t have much use for the South Korean won. The two parties need some medium exchange that is widely accessible, universally trusted, and easily convertible into their local currencies. The dollar is that medium: The South Korean company exchanges won for dollars, buys the pork with those dollars, and then the Mexican farmer exchanges his hard-won greenbacks for pesos. The dollar’s reserve status keeps demand for America’s currency and debt artificially high, and thus, our nation’s borrowing and consumer costs unusually low. But Trump’s erratic and belligerent trade agenda has shaken global investors’ confidence in both America’s economic and political stability. Among bankers and foreign governments, talk of “de-dollarization” has spiked. The dollar’s dominant role in international finance is unlikely to end any time soon. But Trump’s policies have increased the odds of the currency’s future displacement, while driving down its current value. The Trump trade war’s most surprising downside What makes the recent decline in the dollar’s worth alarming is that it wasn’t supposed to happen. Most of the Trump trade war’s adverse consequences were widely anticipated. Tariffs virtually always increase consumer prices, trigger retaliatory measures by other countries, and depress stock values. But conventional economic wisdom held that Trump’s tariffs would make the dollar more valuable. To understand why, one needs to recognize that the international value of currencies is relative: The dollar’s strength is determined by how much foreign currency it can buy. It therefore gains value as other major currencies lose value. Further, the value of a nation’s currency is partly determined by demand for its exports. To purchase Japanese products, American importers must exchange dollars for yen (because Japanese companies require payment in yen). This leads them to bid up the yen’s price on international currency markets. In theory, Trump’s tariffs should have led Americans to buy fewer foreign goods and thus, demand fewer yen, euros, yuan, pesos etc. That should have mechanically reduced the value of those other currencies, thereby increasing the dollar’s international value. What’s more, Trump’s trade agenda was sure to increase economic uncertainty. And in recent decades, whenever global investors got jittery, they tended to buy US Treasury bonds, widely considered the world’s safest asset. These periodic surges in demand for US Treasuries have always driven up the value of the dollar (since investors need dollars to buy US debt). Trump’s advisers tacitly cited these dynamics when they first tried to sell his trade agenda to the public. Treasury Secretary Scott Bessent argued in January that Trump’s tariffs wouldn’t actually raise the cost of imported goods by that much, since his policies would increase the value of the dollar. But this is not what happened. Rather, to the surprise of Trump’s supporters and critics alike, the US Dollar Index has lost about 9 percent of its value since Trump took office. This may be partly due to a benign and temporary factor: The announcement of Trump’s tariffs actually generated a surge in US imports, as American consumers tried to stock up on foreign goods before the duties took full effect. But that doesn’t fully explain the dollar’s decline. Even with the jump in imports, the dollar still shouldn’t have fallen much in recent weeks. After all, Trump’s tariffs have triggered even more global economic uncertainty than anticipated, due to their extraordinary size and scale. And yet, instead of responding to this crisis by piling into US assets, capital appears to be fleeing the United States. One can see this in the rising gap between the yield, or expected return, on American and German bonds. As of this writing, a 10-year US Treasury bond offers a roughly 4.18 percent return, while the yield on a German 10-year bond is only 2.4 percent. Normally, investors would respond to a gap this large by buying less German debt and more American debt, since our nation’s bonds offer a much higher return and are typically considered as safe (if not more safe) than German bonds. And yet now — despite both high US interest rates and global economic uncertainty — investors appear to be moving money out of American assets and into European ones: The dollar has lost 5 percent of its value relative to the euro since the start of April. This extraordinary development has led global analysts to wonder if the dollar’s preeminence might be coming to an end. Why Trump’s policies are undermining the dollar In 1944, the Bretton Woods Agreement established the dollar as the world’s reserve currency. But that framework for international trade broke down in the 1970s. For the past half-century, the dollar has owed its dominant role in the global financial system to America’s economic strengths and political stability, rather than to any diplomatic accord. Those economic strengths are straightforward. The United States boasts the world’s largest economy. This has historically provided global businesses and countries with confidence that the dollar’s value would remain relatively stable over time: A vast and diversified economy is less vulnerable to local shocks than one that is small or highly dependent on the strength of a single sector. And since international economic players have trusted the dollar to retain its value, they’ve been inclined to price goods in that currency and sign contracts that require payment in dollars. Meanwhile, the American economy’s size ensures that there are always lots of buyers and sellers in our bond markets. This makes US Treasuries a relatively stable store of value, since one can buy or sell them in large quantities without triggering large price changes, since there are so many other participants in the American bond market. The depth of the Treasury market was historically reinforced by America’s political stability, which encouraged confidence in our capacity and willingness to pay our debts. Together, these factors have made American debt into a uniquely safe and scalable savings instrument for foreign central banks and investors, a fact that reinforces demand for the dollar. Trump’s policies haven’t eliminated America’s exceptional economic strengths. But they have called our nation’s long-term prosperity, political stability, and creditworthiness into question. What has made Trump’s tariffs so alarming to investors is their sheer irrationality. On “Liberation Day,” the US government declared that every country that runs a bilateral trade surplus with the United States was — by definition — cheating America. And Trump imposed tariffs as high as 46 percent on the exports of US allies in retaliation for this supposed cheating. Yet the administration’s reasoning was nonsensical. There is no reason why the United States should run a trade surplus with every country at once. And there are plenty of innocuous reasons why a foreign nation would sell more goods to Americans than it buys from them. The people of Bangladesh simply cannot afford to buy very many US-made goods, while Americans can easily afford to buy large volumes of Bangladeshi clothing. The administration ultimately paused its so-called reciprocal tariffs for 90 days. But it refused to revoke them outright and kept a 10 percent universal tariff in place, a policy that is itself mindless (why would the US put a tariff on all foreign products, including agricultural goods it cannot physically produce at scale, such as bananas and coffee)? Meanwhile, America abruptly jacked up its tariffs on Chinese goods to 145 percent, effectively ending trade between the world’s two largest economies. The fact that the US government was capable of pursuing policies this unhinged — and hostile toward its core allies — raised questions about its competence as a steward of growth and reliability as an economic partner. As Mark Sobel, US chair of the global economic think-tank OMFIF, told the Financial Times in April, “The trade war is just the latest example of this administration’s contempt for the rest of the world. Being a trusted partner and ally is a key pillar of the US dollar’s dominance, and has been tossed to the wind.” More concretely, if Trump has utter contempt for conventional economic reasoning, norms, and international agreements — as his trade policy indicates — who can be certain that he won’t end the Federal Reserve’s independence or even entertain defaulting on some of America’s debts? This line of thinking appears to have driven investors to look for “safe havens” outside the United States: While the dollar has fallen in recent weeks, the opposite has been true for the world’s other secure stores of wealth, such as the Swiss franc, yen, and gold. For Americans, the end of dollar dominance would come at a steep price The dollar’s status as a global reserve currency isn’t an unmitigated boon to the US. Since that status inflates the dollar’s international value, it renders US exports more expensive to foreign consumers, reducing the global competitiveness of American firms. Nevertheless, the dollar’s dominance is likely beneficial on net to the United States. At the very least, its displacement as global reserve currency would impose significant economic costs on American households. Since investors and nations worldwide need dollars to fulfill their contracts, pay off their debts, and complete financial transactions, there is massive and persistent demand for American assets in general, and sovereign debt in particular. This has enabled the United States to run large budget deficits without suffering a commensurate increase in its borrowing costs. As a result, Americans have faced less of an imperative to choose between paying low tax rates and sustaining their favorite social welfare programs. The end of dollar dominance would force the US government to pay much higher interest rates. That would exacerbate the burden of America’s debt, and make it harder for our government to avoid broad tax hikes or entitlement cuts (or both) in the coming decades. Meanwhile, a permanently weaker dollar would reduce Americans’ living standards. Our nation’s trade deficit is often framed as a great imposition. But to an extent, it means that we are effectively trading something we can effortlessly produce — our currency and debt — for goods and services that other human beings must labor to generate. Most countries would not be able to do this indefinitely without seeing their currencies decline in value. But since the dollar is in such high global demand, we have, in a sense, been able to live off exporting our own money. Were dollar dominance to end, Americans would see their currency devalued — and thus, the real worth of their incomes and savings decline. It is possible that America could eventually develop a new, similarly prosperous economic model. But the attendant process of economic adjustment would be painful. The dollar’s reign won’t end anytime soon For now, the world is only de-dollarizing in relative terms. The US Dollar Index has fallen sharply, but remains higher today than it was in early 2021. And one fundamental obstacle to the dollar’s displacement remains in place: the lack of a viable alternative. Only a similarly large economy with a trusted political system could support a reserve currency as effective as the dollar. And no such economy currently exists. The European Union could theoretically become one. But at present, unlike the US, the EU is a monetary union and not a political and fiscal one (all EU countries use the same currency, but they do not all pay taxes to the same government or fund their sovereign debt through common bonds). Europe’s lack of a centralized treasury or debt-issuing authority undermines its ability to effectively manage its collective economy during times of crisis, as it demonstrated in the aftermath of the 2008 crash. More critically, there isn’t a single unified eurobond market. Instead, Europe offers only fragmented markets for national debt. This means that none of its bond markets boast anywhere near the scale and liquidity of the market for US Treasuries. China, meanwhile, puts heavy restrictions on the movement of money across its borders. This means that the yuan cannot be easily converted into foreign currencies, and is therefore unsuited to global reserve status. Even if China were to remove all capital controls, its weak commitment to the rule of law and relatively small bond market would still make the yuan less attractive than the dollar as a store of value, at least for the foreseeable future. All of this said, discontent with the dollar system was growing even before Trump’s second inauguration. In recent decades, America has repeatedly weaponized the dollar’s centrality to the global financial system. Specifically, we’ve forced other countries to abide by our sanctions or else lose access to the US banking system. That’s caused nations with close economic ties to Iran, Russia, Venezuela, other US adversaries to pine for an alternative reserve currency. Now, Trump has vastly expanded global governments’ and investors’ appetites for another way of organizing global monetary relations. Were the European Union to ever move to greater fiscal union or China to embrace greater financial openness and a modicum of political reform, it’s conceivable that the world would readily transition to an international monetary system with multiple dominant currencies, in which the dollar’s role would be greatly diminished. For ordinary Americans, the more practical and immediate concern is that the dollar appears poised to grow marginally weaker in the coming months and years. With Trump’s tariffs simultaneously spooking foreign investors and diminishing America’s growth prospects, Goldman Sachs expects that the dollar will lose another 6 percent of value relative to the euro and yen over the coming year. With Trump’s tariffs already reducing Americans’ purchasing power — by driving up the cost of imports — the dollar’s depreciation threatens to hit Americans’ finances especially hard. His supporters insist that this “short-term pain” is necessary to bring “long-term gain.” But that is false. Trump’s trade agenda will make Americans poorer both now and in the future. The only question is how extensive and reversible the damage will prove to be.

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How Trump could make Americans permanently poorer