Donald Trump: How the US President is cornering the Fed

Something unusual happened this spring—something that has probably never happened before. In an environment of great political uncertainty and rising US interest rates, the US dollar lost value against other currencies.

So what! You might think. Isn't this a technical detail? Exchange rates fluctuate. And when the US president starts a trade war and thereby stirs up the financial markets, it's not particularly surprising that the dollar is weakening.

The current development is remarkable because it reveals a new pattern. In the past, the dollar always strengthened when uncertainty in the global economy increased. This was even the case in the fall of 2008, when the financial crisis swept across the world – a crisis that originated in the USA and was triggered by the collapse of the Wall Street bank Lehman Brothers. Investors from all over the world sought refuge in the safe haven of America. They bought dollars and US Treasury bonds. As a result, the currency strengthened, and interest rates fell. A similar situation occurred during Trump's first term in office, when the trade conflict with China led to an appreciation of the dollar.

The dollar also benefited during other crises in the recent past: Whether the Corona crisis in 2020 or the beginning of the Ukraine war in 2022 – America offered unsettled investors a safe haven to which they could seek refuge during geopolitical storms.

America has always played it safe, even when it messed up. That's how it's been in the past. But this time, things are different.

America is apparently losing its status as a safe haven. The world's largest financial market and by far the most important international currency are no longer impregnable. It's possible that the dollar is about to lose its role as the dominant global currency.

The issue is so significant that the Federal Reserve Board of Governors addressed it in detail at its meeting in early May. The minutes , released last week, state that some participants noted that if U.S. financial markets lose their reputation as a safe haven, there could be "long-lasting consequences for the American economy." This bodes ominously.

A move away from the dollar would be a turning point in monetary policy. For generations, the US dollar has been the dominant international currency. The USA has profited enormously from this – through low interest rates and cheap imports. Companies, the government, and citizens are spending more money than they can actually afford because foreigners are willing to invest enormous sums in the USA or in companies. As a result, America has become the largest debtor economy on the planet. The accumulated net liabilities recently exceeded 26 trillion (!) dollars .

The "long-lasting effects" discussed by the Fed Board of Governors therefore mean nothing other than a – at least partial – reversal of this debtor position of the past decades. An increasingly weaker dollar would make imported goods in the US more expensive and fuel inflation , in addition to the tariffs Trump has imposed or threatened. Higher interest rates would make investments more difficult for companies; homebuyers would have to prepare for permanently higher financing costs. The government would have to pay significantly higher interest rates on its high debt. These are concerns that also trouble top bankers like JPMorgan CEO Jamie Dimon (69), who recently warned of a "crack in the bond market."

A global economy without the dollar as the global currency is conceivable, perhaps even desirable. However, such a loss of status would be enormously painful for the United States.

A bleak outlook, which also explains the ambivalent statements made by Trump's people regarding the dollar. On the one hand, they would like to see a significant devaluation to give US industry a price advantage over foreign competitors. On the other hand, they want low capital market interest rates to be able to continue running high government deficits and keep stock prices high.

This presents a contradiction that is almost impossible to resolve: Experience shows that a weaker dollar will be accompanied by significant interest rate increases. Those who invest their money in America while the currency continues to depreciate will demand higher returns to compensate for the devaluation.

As a precaution, the US President has already threatened all countries that turn away from the dollar and use other international currencies. It's hard to imagine that such a wish-fulfillment monetary policy will ultimately succeed.

Of course, the dollar is still the most important international currency. Even the recent weakness, however extraordinary given the circumstances, is by no means dramatic. Relative to its most important trading partners, the US currency is still effectively stronger than it has been for most of the past 20 years, as calculations by the Bank for International Settlements show.

According to the European Central Bank (ECB), the dollar still leads by a wide margin in international financial transactions, bank deposits, loans, foreign exchange market transactions, and official currency reserves. It is the only currency on the planet whose use far exceeds the weight of the underlying economy.

And yet, its international role is gradually diminishing. China is conducting an ever-increasing share of its foreign trade in yuan. Central banks, especially in emerging Asian markets, are dwindling their enormous dollar reserves and holding an ever-increasing share (currently 20 percent) in gold, as ECB President Christine Lagarde recently reported. (Watch out for the ECB Council meeting on Thursday .)

There's no doubt that a lot has been happening in the international monetary system. We're entering phase four since the end of World War II. And the outlines of what this new monetary policy era will look like are emerging.

In phase one, between 1945 and the early 1970s, the dollar was the monetary central star of the non-Soviet part of the world. The US currency was backed by gold. The other currencies were pegged to it at fixed but adjustable exchange rates. In the early 1970s, this system fell apart. In the wake of the Vietnam War and internal unrest, the US abolished the gold standard.

In phase two, the fixed exchange rates of the postwar decades gave way to a flexible, market-driven arrangement. Nevertheless, the dollar retained its dominance. Other currencies, particularly the Japanese yen, the Deutsche Mark, and the British pound, played supporting roles.

In phase three , the dollar's dominance increased once again. In the wake of globalization beginning in the 1990s, many emerging economies built up gigantic currency reserves to protect themselves against upheavals in the financial markets. Once again, the dollar was the currency of choice. It offered several mutually reinforcing advantages: large, liquid financial markets unlike any other in the world; an independent central bank committed to monetary stability; a constitutional state with trustworthy courts and institutions; and a political-military concentration of power capable of enforcing its rules worldwide when necessary.

Only America could offer this mutual intertwining of financial power and global power. But that is changing – in several respects. The US's former economic, political, and military preponderance has vanished. China's rise and Europe's integration have created large (albeit so far incomplete) capital markets. Now the Trump administration is questioning the US's unconditional commitment to the rule of law at home and the independence of the Federal Reserve, as well as the political-military alliances and partnerships that the US has cultivated around the globe for 80 years. China's military buildup is challenging America's status as the globally dominant military power.

In phase four, there will be no switch from one global currency to another, but rather greater diversity. As economic historian Barry Eichengreen of the University of Berkeley and his co-authors have demonstrated in a fascinating book on the history and future of global currencies, a quasi-monopoly on monetary policy is not necessary to ensure international flows of goods and capital. Technological advances enable the exchange of different currencies at low cost. A system based on several pillars would potentially be more stable because it could support several countries that could intervene to stabilize the system in crisis situations.

This constellation offers Europe a historic opportunity ( see the manager magazin analysis ). Unlike China, whose autocratic system fails to guarantee the rule of law, the eurozone is a large economy with a reliable legal framework and credible institutions. (New figures on euro inflation will be released Tuesday .) European financial markets are open, unlike China's, where capital controls and exchange restrictions continue to restrict cross-border exchange.

The euro already accounts for around one-fifth of all international transactions, bank deposits, loans, and official currency reserves. This roughly corresponds to the economic weight of the eurozone. China's yuan, on the other hand, plays only a minor role in these areas, even though, as mentioned, it is gaining market share in Chinese trade with the rest of the world.

Further development of a truly common financial market, a common fiscal policy, and—again—a common European military might could make the euro significantly more attractive internationally. Even better: We Europeans could benefit significantly from this. Currently, Europe exports hundreds of billions of euros in surplus savings, not least to the United States. If we could succeed in productively investing some of this money here, that would be a tremendous development.

Under Trump, America is in the process of economically mutilating itself. This is tragic. On this side of the Atlantic, we should not allow this to deter us – and resolutely forge our own path.

Monday

Tuesday

Paris – Pulse of the West – The OECD, the club of market democracies, publishes its biannual “Economic Outlook”.

Luxembourg – Prices (in euros) – The EU statistics agency Eurostat publishes a flash estimate of inflation in the eurozone in May.

AGM Season I – Annual General Meetings of Rhön-Klinikum, Adesso, Evotec.

Wednesday

Frankfurt – Pulse of the economy – The mechanical engineering association VDMA reports on incoming orders in the industry.

AGM Season II – Annual General Meetings of Air France-KLM, Ströer, Cewe, Koenig & Bauer, Airbnb.

Thursday

Frankfurt – Lagarde international – ECB Governing Council meeting: The governing body will decide on the monetary policy stance. Questions about President Lagarde's future are likely to arise at the press conference. The Financial Times had reported that she was being considered as the future head of the World Economic Forum in Davos.

Brussels – Shadow of Trump – NATO Defense Ministers' Meeting: The governments of the member states are preparing for the upcoming NATO summit in The Hague. The big question: Is the alliance's commitment to mutual assistance still credible?

AGM Season III – Annual General Meetings of Sixt, GFT, Gerresheimer, Saint-Gobain, Scout24, Springer Nature, Walmart, PayPal, Salesforce.

Friday

Wiesbaden – After the tariff hammer – The Federal Statistical Office reports on German exports in April, the first month after Trump’s “Liberation Day” tariff barrage.