Punishing the No-Shows to the Dollar Party
Donald Trump’s proposal this week to protect the dollar’s reserve status mirrors the illogic of a vindictive party host
Imagine hosting the coolest cookouts on your block. You have to pay for hot dogs and beer, but neighbors love coming so much they won’t deny you any lawn equipment or kitchen gadget you want to borrow. While hardly a perfect analogy, the dollar’s reserve currency status rests on a similar bargain. We tolerate a slightly expensive exchange rate, but in return for access to the world’s best financial markets everyone lends us boatloads of money on the cheap.
Now say you notice a few friends showing up for parties at the new neighbor in the flashy McMansion next door. Imagine your bruised ego leads you to announce that anyone parked in that driveway will have to send you their share of the cost of the festivities they missed at your house.
Crazy, right? But newest policy idea from President Donald Trump to “protect” the dollar’s status rests on the same logic.
Amid a wild election campaign, a tumultuous Tuesday night debate and polls still showing a tossup, Trump’s aside about the dollar at a rally in Wisconsin on Saturday may not sway many votes. But the potential consequences of the proposal are so devastating for the global economy that it’s important to nip in the bud before it gains credibility along with other perplexing proposals. (See “Wall, Mexico will pay for the” and “Immigrants, Round up 15 million”)
To fully appreciate the messiness of the idea, it’s useful to quote it in context and in full as others have done:
“We will rebuild our cities including Washington, D.C. Our cities are a mess, and they’re very dangerous places. We’re going to make them safe clean, and beautiful again. And we will keep the US dollar as the world’s reserve currency. And it is currently under major siege. Many countries are leaving the dollar. They’re not going to leave the dollar with me. I’ll say, ‘If you leave the dollar, you’re not doing business with the United States because we’re going to put a hundred percent tariff on your goods.’ ‘Sir, we would like very much to get back to the dollar immediately. Thank you very much.’”
There’s a long list of problems here even if you infer the most benign interpretation that “leave the dollar” means a country’s decision to reduce its sovereign holdings in U.S. currency. But for now, let’s just cover the top five.
1. Countries hold dollars because they think it’s the monetary equivalent of the coolest party on the street: everyone else uses dollars, they offer access to the deepest financial markets and they are backed by the world’s most innovative economy. Slapping 100% tariffs on anyone choosing alternatives immediately makes the dollar less attractive for everyone. Every party turns much less fun when the host grows angry and vindictive.
2. Countries aren’t really leaving the dollar. While the IMF records dollar reserves have declined from 70% to 60% over the last 25 years, largely as new currencies offer the opportunity for diversification. But this is still well above levels in the 1980s and 90s. For all the talk about American decline, the dollar still looks like the best party in town.
3. If and when the day comes when foreigners do start accumulating other currencies instead of dollars, the loss of reserve currency status will be the very least of America’s concerns. Along the way, we will have made our capital markets less attractive and our economy less innovative. Imagine that great party you throw, but the pool has turned dark with algae, the band has been replaced by a Spotify playlist and there is nothing to drink but Bud Lite.
4. Trump’s other main promise concerning the dollar is to make it weaker so that U.S. exporters will have an easier time competing. But even with the threat of tariffs, it’s hard to get other countries to hold dollars when they know the issuer is deliberately trying to make them less valuable. Again, you can’t expect people to keep coming to your party if you’re going to charge them for not showing up.
5. Governments don’t really make decisions about dollar holdings. Investors do. The currencies of sovereign holdings predominantly reflect choices of private trade and investment flows. You may insist that people come to your party, but they will always be checking out the alternatives and choosing that McMansion from time to time. And if they do come back to your events, they won’t ask permission.
And they definitely won’t call you ‘sir.’
Thank you for your insightful post, which indeed touches on several inconvenient truths for the Republican candidats, assuming he is capable of approaching the issue strategically. However, I have a couple of observations:
Political campaign events: Have you seen any recently? The era of content-driven discourse and reasoned debate seems long gone. Now, it’s all about chants, cheers, slogans, and occasionally bullets. The likelihood that a Trump administration would enact this so-called 'program' is virtually nil.
The economy: This is an immense wildcard in the upcoming election. While Trump's first term deserved some credit, if not only for understanding corporate anxieties about overexposure to China, Biden’s economic policies are harder to evaluate (I am being generous: two glasses of Bordeaux and I will deem them scholastic; give me a mojito and I will tell you what I really think). The economy is showing signs of weakness at a crucial time, and Harris has been notably quiet—when she does speak, her economic stance is cryptic at best. As bizarre as it may seem, Trump's rhetoric about the USD could resonate patriotically, even if it lacks substance.
Foreign relations: We need to move away from the naive notion that nowadays' international diplomacy is a matter of gentle, polite exchanges. We’re facing a highly antagonistic global order, with a counter-alliance of China, Russia, Iran, North Korea, and Pakistan becoming more vocal. Countries like India, Brazil, South Africa, and Saudi Arabia might remain neutral, but the development of alternative payment systems and China’s persistent efforts to internationalize the RMB are weakening the USD’s reserve status - they have been sloppy so far, but at least they are in line with a more antagonistic world. While Trump’s remarks may seem nonsensical, they reflect an acknowledgment of the turbulent and hostile international landscape. Harris must avoid the illusion that we are living in Xanadu.
Very enjoyable post, and your points are spot on. The main weakness of the block party analogy is that "cool" can be a very ephemeral connotation, gone with a sudden change in fashions, whereas the reserve status of a currency rests on structural factors that take much longer to change. Ironic of course to see a politician "defending" the dollar while proposing some policies that would erode its structural attractiveness -- the equivalent of firing the band. On the bright side (for the US), it's all relative, and when you look around you see that the stately old European villa has filled in the pool with mud to save on energy bills, and in China's McMansion half the lights have gone out and the porch looks shaky... Maybe this gives us enough time for our politicians to learn some basic economics...