The Trump administration increasingly seems convinced that the US dollar’s status as the world’s reserve currency is a burden, not the “exorbitant privilege” that it is often said to be. Key economic advisers such as Stephen Miran believe that the persistent strength of the dollar has driven the deindustrialisation of the American economy by making exports less competitive.
Economists can legitimately debate this. There could even be a smidgen of truth in it, although blaming the rest of the world conveniently ignores poor decisions willingly made by US corporations and politicians. However, treating the dollar’s unique status and strength as yet another example of America being ripped off ignores some obvious benefits.
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The end of American exceptionalism
The most common theme among investors outside the US is that American exceptionalism is over. The rest of the world has been rattled by poor governance, soaring deficits and growing fears of some new anti-foreigner measures (section 899, a provision in the new budget bill that would increase taxes on US income for foreign investors, is constantly mentioned).
It would be a huge exaggeration to say that investors are fleeing the US, but it is clear that they are reconsidering the structural overweight to American assets that most have. The consequences go beyond Treasuries, since other US assets also benefit from strong demand. For example, reserve currency status has also created a huge cost of capital advantage for US companies, argues Alec Cutler of Orbis. This will now shrink, he says – another reason, on top of high valuations and soaring capital expenditure for big tech, why US stocks will enjoy fewer advantages in future.
Disorderly change
Still, this sounds like a gradual change – a reason to be less bullish on the US, but not a source of vast upheaval. While the dollar’s share of central bank reserves has declined from 60% in the early 2000s to about 46% now, according to the European Central Bank, it is dominant in payments (almost 90% of currency trades involve it). It is impossible to imagine a rapid move away from the dollar: no other currency has the same liquidity and market depth.
Yet the unpredictability of the US government – the risk that it will destroy one of its strengths because it sees it as a weakness – means that we can’t dismiss this risk. Sometimes, disorderly change is forced on us. This may be one reason for gold’s continued strength. The trend in reserves since 2008 (see chart) points to demand for a reserve asset that no government controls. Donald Trump will probably accelerate that shift.
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