This time really is different for the dollar, writes Kenneth Rogoff
The greenback was already in decline. Donald Trump will accelerate the process
TO PARAPHRASE a common saying: it ain’t what you don’t know that kills you. It’s what you think you know that ain’t so. Nothing could better describe the numb-skulled thinking behind the havoc that President Donald Trump and his trade Rasputin, Peter Navarro, have wrought on the global economy. Among the likely casualties will be the supreme status of the dollar. Although the greenback will almost certainly remain the world’s dominant currency for at least a couple more decades, it will probably fall several notches. Expect the yuan and the euro to encroach on the dollar in the legal economy. Cryptocurrencies will do the same in the underground economy, which is roughly a fifth of global GDP. Reduced market share will mean higher interest rates on long-term dollar debt, and a weakening of the effectiveness of American financial sanctions, among other problems.
Even before Mr Trump, dollar dominance had been in slow decline. There are many measures of the dollar’s footprint on the global economy, including central-bank reserve holdings, the currency used in trade invoicing and the denomination of international borrowing. A particularly useful one is what currency central banks focus on as their exchange-rate anchor or reference currency. Given that national central banks have intricate knowledge of their economies’ inner workings and how exchange-rate movements affect them, anchor or reference currency choices may be thought of as a portmanteau measure of dominance.
By this measure, dollar dominance peaked around 2015, after which China gradually began to make its currency more flexible. This was a change long in the making, since a large economy like China’s can experience very different business cycles than America’s, and there is no reason to make its central bank dance to the Federal Reserve’s tune. American sanctions on Russia, including the freezing of over $300bn-worth of central-bank reserves, have also put a fire under China’s efforts to decouple, given the likelihood of an eventual reckoning over Taiwan.
As China’s exchange-rate regime has evolved, so too have those of its neighbours, given that China is at least as important a trading partner as America for most. With Asia constituting roughly half of the dollar bloc—ie, economies that focus on the dollar when managing their own currency’s exchange rates—a gradual splintering was already under way. Europe, too, chafes at the tentacles of control that dollar dominance gives America; the European Central Bank’s moves to establish a central-bank digital currency should be viewed in part as an effort to compete more effectively with the dollar.
The biggest challenges to dollar dominance come from within, including America’s unsustainable debt trajectory. It is already under strain from the inevitable ending of a period of very low long-term real interest rates. If Mr Trump’s chaos keeps undermining the dollar’s “exorbitant privilege”—the borrowing discount America’s government enjoys thanks to the greenback’s dominance—rates will rise even more.
A related source of concern is the increasing willingness of both Democrats and Republicans to challenge the Fed’s independence. Mr Trump’s extraordinary attacks on the Fed, which he wants to blame for the recession his tariffs might cause, has taken Fed-bashing to another level. Don’t think, though, that Fed independence would have been entirely secure under progressives, who want the Fed to focus more on the environment, inequality and social justice, and ultimately to create a central-bank digital currency to suck money out of the private banking system and redirect credit towards government-favoured sectors.
Mr Trump did not start the dollar’s decline, but he is likely to prove a powerful accelerant. Aside from upending a global trade regime in which America was a big winner, he is working hard to undermine almost every other pillar of dollar dominance. He has rightly cut back illegal immigration—but he does not seem to care much for legal immigration either. He seems hell-bent on crushing research at the nation’s top universities, which have long been a major source of innovation and growth.
Above all, Mr Trump’s broad challenge to the rule of law weakens the case for dollar exceptionalism. Until now, trust in the fairness of America’s legal system has helped convince investors that American assets are among the safest in the world. This includes not just Treasuries, but stocks, corporate bonds, property and more. The prices may go up and down, but at least you own what you own. Now, if Mr Trump’s efforts to vastly extend presidential power succeed, foreign holders of US assets will feel less secure.
The great Danish chess player Bent Larsen, when asked if he preferred to be lucky or good, replied “both”. Americans tend to emphasise how good the American system has been, as the dollar has beaten back one challenger after another, from the Soviet Union to Japan to Europe, and now perhaps China and crypto. But they forget how many turns of luck America has had along the way. These include, among others, the collapse of mid-1960s Soviet economic reforms that might have turned the country into something more like latter-day China; Japan’s mistake in allowing itself to be browbeaten in the 1985 Plaza accord when its monetary-policy framework and financial regulators were not yet ready for prime time; and the euro zone’s decision to prematurely include Greece.
This time, unfortunately, is different. Unless Mr Trump reins in his chaotic trade policy—he could start by firing his Rasputin—America’s luck looks set to run out. ■
Kenneth Rogoff is a professor at Harvard University and the author of “Our Dollar, Your Problem: An Insider’s View of Seven Turbulent Decades of Global Finance and the Road Ahead”.