What Trump 2.0 means for the US dollar

Presumably, the thinking here is that if tariffs can block out imports while exporters become more competitive thanks to a weaker US dollar, then the US trade deficit will shrink. But tariffs and a weaker US dollar did not shrink the trade deficit during his first term, and they won’t in the second term either.

The nub of the issue here is a fundamental misunderstanding of trade. A trade deficit occurs because savings in the domestic economy are insufficient to fund the investment firms and the government want to do. The deficiency of savings has to be met by foreign savers, and they accumulate the US dollars needed to invest in the US through selling more goods to the US than the US exports abroad. Sometimes foreign savers want to send too much to the US, and the dollar appreciates. But sometimes it is not enough and the dollar can find itself under pressure.

What impact can tariffs have? In theory at least, tariffs will lead towards improvement in the US’s trade balance (assuming nobody retaliates). That sounds good, but as we noted earlier, the trade imbalance is fundamentally determined by the imbalance between domestic savings and investment, and if this is unaffected by tariffs, then trade improvement cannot happen. What is needed to prevent it from happening is an appreciation of the US dollar as this counterbalances the improvement in trade that comes from the tariffs.

In short, there is a fundamental contradiction between a policy that includes both tariffs and a desire for dollar weakness. So far this argument has assumed that the imbalance between domestic saving and investment stays constant. But what if it changes? Tax cuts increase the budget deficit, as most independent assessments of Trump’s fiscal policy suspect will happen. Of course, defenders of Trump’s policies will point out that tariffs are a tax and hence government revenues will increase, counterbalancing the depletion of revenues from domestic tax cuts.

However, there are a couple of problems here. The first is that tariffs are likely to reduce the demand for imports, likely meaning that any revenue gain from this source will fall far short of the cost of domestic tax cuts. A second issue is that a bigger budget deficit, and hence an even larger deficiency in net domestic savings, implies an even bigger trade deficit is needed as the US is forced to suck in even more foreign savings to meet the domestic savings deficiency, and this means an even stronger US dollar.

So far, the argument here seems to suggest that Trump cannot hope to have higher tariffs and a weaker dollar, and particularly not if his policies are increasing the budget deficit. But this is in theory? What about in practice? During his 2017-2021 term, Trump did introduce tariffs, the trade balance did deteriorate, and the dollar did fall. In other words, what should happen in theory does not always happen in practice. Why is this?

The reason largely comes down to the fact that the FX market is not a predictable animal. The dollar should move if all the buying and selling of dollars was done for the purposes of trade and savings flows, as we’ve mentioned. But clearly this is not the case; there is a truly enormous amount of froth that sits on top of these more ‘fundamental’ trade and savings flows, and this can lead to the breakdown of the sorts of relationships we described above.

If that was the case during Trump’s first period in office, could it happen a second time starting from next January? In the Standard Bank’s view, that’s very possible. So, whatever strength in the US dollar we see now will likely dissipate over the long haul. Trump’s first term saw the dollar finish some 10% lower than when he came into office. The Standard Bank thinks that 10% is likely to be the minimum, we will see between January 2025 and January 2029.