Donald Trump Wants a Strong America, But Does He Want a Strong Dollar...?

What Happened?

After gaining almost non-stop since September, the U.S. dollar has paused.

The U.S. Dollar Index, which measures the greenback against a basket of foreign currencies, is now at a key technical level.

Since early 2023, it has traded up towards this level five times. But each time it has found resistance against further gains and fallen back by around 10%.

The reasons some analysts give for the recent stronger dollar was the talk from Donald Trump about imposing tariffs on imports. Although there are reasons to be skeptical about that.

Even though Trump had narrowed the gap in opinion polls by mid-October, he was still trailing Kamala Harris by two percentage points right up until the last week of October.

Regardless, the dollar has topped out. Let’s look at what that means…

Why it Matters

The U.S. dollar is still the world’s reserve currency. That means the dollar and assets denominated in dollars, such as U.S. government bonds and treasurys remain in high demand within the U.S. and overseas.

The dollar remains the default currency for most international trade agreements, and almost all commodities are traded with the U.S. dollar price as the reference point.

Having the global reserve currency as the domestic currency is a big benefit for the U.S. government and for U.S. citizens. Even though it may sometimes not seem like it, the reserve currency status can help keep both interest rates and inflation lower than they otherwise would be.

That’s because the reserve currency status effectively creates an automatic demand for U.S. dollars. Governments (or their central banks) around the world hold dollars in order to help them manage the value of their own currency.

And corporations too. They tend not to just put money in the bank.

Instead they instruct their corporate treasury to invest in what the market calls ‘risk free’ bonds. U.S. firms will invest most of this in U.S. bonds. But foreign companies will do so too. That’s especially so if they have significant U.S. earnings, or they perceive their own country’s bonds as being a higher risk.

However, having a reserve currency also comes with responsibilities. The responsibility to not abuse the power of having the reserve currency by devaluing it to the extent that investors no longer want to own it and no longer trust it.

It’s this issue that has faced the U.S. dollar perhaps more than ever before over the past 15 years.

How it Affects You

For now, the reserve currency status of the U.S. dollars to be safe. Since the Great Recession in 2008/2009, there has been talk about an alternative to the dollar.

There have been several ideas. When the euro came into being earlier this century, many thought it could be a new global reserve currency. That idea went away in 2011–2012 during the European debt crisis.

Others thought the Chinese renminbi could take the place of the U.S. dollar. But one of the key features of any currency, including a reserve currency, is that there aren’t capital controls on assets in that country. That rules out China and its currency.

Then more recently, the BRICS countries (Brazil, Russia, India, China, and South Africa) seemed to be developing a global traded single currency, backed by their domestic currencies. But again, each of those countries, to varying degrees, impose capital controls, making it less appealing for risk-averse investors.

(Remember, a big feature of a reserve currency is trust.)

That means for now, the U.S. dollar’s reserve currency status seems safe. That’s a big advantage for America, and a big advantage for Americans.

But it’s also worth noting that when Mr Trump won the 2016 election, a similar pattern played out. The dollar increased prior to election day, and through to the end of the year. After that, the dollar lost about 10% of its value in the following 12 months. Will that full pattern repeat?

Mr Trump has promised ‘America First’. Will that include having a strong U.S. dollar? If so, the next few years could be very lucrative for American investors.