President Trump and his administration have repeatedly voiced that they consider the US dollar to be too strong and that they favour a weaker dollar, as they intend to transform the US from a consumption-driven economy with a massive trade deficit into a manufacturing powerhouse.
With the real trade-weighted US dollar index around 20% above its 30-year average, this concern seems to be justified. Moreover, the US dollar also screens as one of the most overvalued currencies within the G10 FX universe. While the dollar’s current strength can be attributed to various factors such as the strength of the US cycle and the Fed’s relative hawkishness to a considerable extent, some argue that the persistence of its high valuation is related to what has become known as ‘Triffin’s dilemma’. In the Triffin world, the persistent demand for dollar reserves causes the US dollar to be more highly valued than in an FX equilibrium balancing global trade.
‘Mar-a-Lago Accord’ has gained traction
To address this imbalance, President Trump’s advisors have floated various ideas over time, of which a potential ‘Mar-a-Lago Accord’ has perhaps gained the most attention. According to this idea, the world’s largest economies would coordinate their monetary and fiscal policies to allow the dollar to weaken against major currencies, similar to the ‘Plaza Accord of 1985’. Yet it has remained unclear how the Trump administration could ultimately accomplish such a deal as today’s geopolitical situation is very different from the post-Bretton Woods era of the 1980s, when the policies of the US and its partners were more aligned. The Trump administration now faces a much more fragmented world, in which some important US trade partners are less friendly than its European allies. The divergence of political objectives further complicates policy coordination across continents. Still, the large size of dollar reserve holdings across the globe, would give the US significant leverage over their holders.
One proposal envisages the Department of Treasury to issue long-term government bonds, or ‘century bonds’. It could force its allies to use their dollar holdings to buy these bonds or to swap their existing Treasury bills. In case of a refusal to comply, the US could retaliate by revoking security guarantees to military partners or impose punitive measures such as tariffs. Others have noted that the continued provision of existing US dollar liquidity swap lines that the Fed has maintained with major Western central banks since the global financial crisis may represent another incentive to remain inside the US security and economic umbrella. Century bonds would provide potentially cheap long-term funding for the US government and spread US dollar interest rate risk to foreign holders. These measures would make dollar holdings for foreigners less attractive and weaken the dollar in the longer run.
‘User fee’ on US government bond holdings?
A further idea has garnered significant attention as of late. In his November policy paper, Stephen Miran, economic advisor to President Trump, discusses how the International Emergency Economic Powers Act (IEEPA), signed into law in 1977, could be used to render the accumulation of US dollar reserves less attractive by allowing the US Treasury to impose a ‘user fee’ on US government bond holdings. Such a fee would be relatively straightforward to implement by withholding a portion of interest payments on US Treasury bond holdings. According to the logic of the Trump administration, holders of US dollar reserves represent a burden on the American export sector, as the incremental demand for US Treasury bonds additionally strengthens the US dollar, making US manufactures less competitive in the global market.
The window of opportunity may have already closed
Stephen Miran’s paper explicitly acknowledges that the imposition of the before-mentioned policies would almost certainly induce volatility in financial markets, necessitating a very gradual approach in order to mitigate risks. While Miran concludes that “the path to reconfigure the global and financial systems to America’s benefit is narrow” and “will require careful planning and precise execution”, President Trump and his administration may have already gone too far in recent weeks. We are inclined to think that the damage to the credibility of US institutions could be already too large for the proclaimed path to pan out, implying that the window of opportunity for a gradual implementation of the envisaged policy mix may have essentially closed. Given that markets trade on expectations and rumours rather than facts, speculation has already begun to inflict some damage, reflected in high market uncertainty and rising volatility. These, in turn, have begun to affect dollar yields while pushing the price of gold higher.
Should Donald Trump’s administration move ahead with the implementation of the prediscussed policies regardless of the market’s warnings, it would certainly have negative consequences for the US dollar and its status as the world’s most important reserve currency. The policies would be particularly harmful for economies with large FX reserves, as both – century bonds or a fee on US Treasury bond holdings – could inflict significant losses on their central banks’ dollar reserves. While Asian central banks constitute major holders of dollar reserves, the Swiss National Bank’s dollar reserves of close to $300bn suggest that its balance sheet is particularly vulnerable to adverse US policies.
Tariff rhetoric supports bouts of dollar strength
Ironically, it currently looks as if the need for a coordinated multilateral policy effort to weaken the dollar could diminish going forward. The dollar increasingly faces cyclical headwinds as domestic macro data are softening and China and Europe are ramping up their fiscal efforts. President Trump and Treasury Secretary Bessent indicated in recent interviews that their administration is willing to tolerate a period of softer growth as the administration wants to put more emphasis on private investment. Economic surprise indicators have turned less favourable for the US, while euro area surprises are rebounding. On the rates side, this is reflected in a narrowing differential between US and euro area government bond yields, suggesting that the dollar is likely past its peak and will weaken in the longer run. In the near term, the periodic flare up of hawkish tariff rhetoric supports bouts of dollar strength. Yet the dollar’s return to its January peak appears to have become significantly less likely in the current environment.
