It weakened the basics of the US, improved investors’ sentiment in Europe, and combined with President Trump’s trade war led to questions about the durability of the dollar.
The November 2024 election of Donald Trump initially raised the US dollar as the currency was supported by higher tariffs and stimulus outlook for the US economy. However, the new president’s intention to reform the global trade and financial system could lead to greenbacks falling backwards for the medium to long term. The recent decline in currency could be the onset of a deeper underlying trend, with Trump’s second term showing that the dollar will lose the dominant position he has enjoyed over the past decade.
Is this the end of the so-called “golden age” of the US dollar? This is a question that everyone is asking because of the country’s rising debt, even though the dollar has beaten the odds over the past 15 years.
The status of a currency reserve, a safe haven amid geopolitical tensions – particularly the Russian-Ukraine War – strengthened by safe haven amid affirmative momentum towards American exceptionalism and interest rates, the dollar has steadily risen and is now overvalued. These factors combined have encouraged many international investors to expose the majority of their investments to the dollar. Over time, they forgot the risks that this excess exposure implies.
Since 2008 and the subprime crisis, the dollar index (the average price of the dollar compared to the basket of global currencies) has risen by more than 40%, with a slight sense of relaxation (it has only been four years in the last 15 years).
However, by weakening the foundation, he sent the dollar downward correction. Recent US economic data falls below expectations, raising concerns about the country’s technology sector and raises questions about the resilience of the US economy.
European Renaissance
Announcement of huge investment plans in Germany and defence spending in Europe – implying the possibility of revisions to fiscal rules – hope that the war in Ukraine will soon end, and hope that the sentiment of European investors will improve.
In fact, the dollar suffers from this change in perception, already losing 4% against European currency from its peak at the beginning of the year, but the global dollar index fell by 5%. In Trump’s trade war and his plan to restructure the global financial system, these factors have already been significantly more impacted, putting the dollar in greater risk.
The restructuring, theorized by Stephen Milan, senior economic adviser to Donald Trump, is based on the belief that the dollar must be depreciated to allow the US industrialization. Tariffs are a central feature of his strategy, urging other countries to reach a currency agreement. This is called the “Mar-a-Lago” contract. This is similar to past currency contracts named according to the locations they signed, such as Bretton Woods (1944), Plaza (1985), and Louvres (1987).
Punitive measures
Milan’s theory is based on several factors. In 2018, the effects of the trade war were largely mitigated by the diversion of some Chinese imports through transport countries. This has led Trump to set up blanket tariffs not only as a punitive measure but also to raise the weight of tariffs on the overall income of federal states.
Unlike 2018, today’s tariffs serve as economic tools with several objectives beyond mere negotiation leverage. They are used to restore the country’s trade balance, sanction other countries for economic or national security reasons, generate tax revenue and reduce the country’s deficit.
Furthermore, the dollar overvaluation is attributed to accumulation of dollar reserves by governments seeking safe shelters. However, this trend has already reversed in recent years, and could attract even more speed when the global financial system is raised in question.
The “derailment” process is also going smoothly, with the dollar weighting of the world currency reserves diminishing since sanctions on Russia. This trend is expected to continue for wrestling matches launched by the Trump administration. The first benefit of “derailment” is the rising prices of gold, which has become a major reserve asset in the absence of a currency that can provide a true alternative to the dollar. The price of ounces of gold rose more than 60% to $2,920. However, it is difficult to achieve a “Mar-a-Lago” contract.
Times have changed since the Plaza contract. Today, much of the world’s dollar reserves are held by countries in Asia and the Middle East, and are no longer European countries. The former could result in fewer reconciliation with the US than there were Europeans during the Cold War. The trade war, and subsequent tensions and negotiations, should encourage higher volatility across the currency market in the coming months.
The zero rate monetary policy implemented by major global central banks between 2011 and 2022 has anesthetized the foreign exchange market. This lack of volatility and a strong dollar have encouraged many investors to retreat from currency risk and overlook the currency hedging strategy of recent years. This risk cannot be ignored today.
Benjamin Dubois, Head of Overlay Management, Edmund de Rothschild Asset Management
