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The US game plan is very simple. First torpedo its trading partners with an unbearable escalation in tariffs, then offer rebates in tariff against commitments to formal or informal arrangements of coordinated interventions to weaken the dollar
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Dado Ruvic
The Liberation Day (L-Day) tariffs were not the first of the Trump shocks, nor will it be the last. Yet, the tariffs have already perturbed the equilibrium in manner that it is best for monetary and fiscal policies to brace up to provide a crash pad.
Tariffs are typically a supply-side shock that constricts imports and reduces aggregate supply. However, the scale at which tariffs have been hiked, they are bound to depress aggregate demand.
Business and consumer confidence, as well as asset prices are tumbling. Effects will be magnified by multiple ways in which financial accelerators will work. To add to this, worldwide retail inflation, akin to cost-push, is likely to push the global economy into stagflation.
Trump firmly believes that “It’s Americas turn to prosper”. His expansionist agenda can cause further topsy-turvy chain reactions in financial markets. He is moving with alacrity. Tariffs are not the only tool in his strategy. Dismantling non-tarff barriers facing the US will follow. More importantly, the conceived ‘Mar-a-Lago Accord’ to weaken the US dollar is yet to playout.
The market consensus has moved to dollar depreciation in 2025. Dollar index peaked on January 13, 2025, rising by 6.3 per cent from 5th November Presidential elections. Since then, all the appreciation has been wiped out. Same is the case with the S&P500 and Tesla stock price.
Yet, Trump administration is not deterred. The US game plan is very simple. First torpedo its trading partners with an unbearable escalation in tariffs, then offer rebates in tariff against commitments to formal or informal arrangements of coordinated interventions to weaken the US dollar.
Triffin dilemma
Stephen Miran, a Harvard PhD senior strategist at Hudson Bay, who now Chairs the Council of Economic Advisors, had spelled it out in his November 2024 strategy paper. He blamed the US woes on the Triffin dilemma. Not sure if our PMEAC, that include market economists and strategists, has taken note of the paper and prepared a counter strategy paper.
Robert Triffin explained that a country that supplies global reserve currency must run balance of payment (BoP) deficits to enable the rest of the world to acquire dollars for payments and building reserves. Therefore, US trade deficits are inevitable. French Finance Minister, d’Estaing, had countered the argument that this was a disadvantage, pointing out that as issuer of the reserve currency, the US enjoys ‘exorbitant privilege’ in being able to finance its imports in its own currency without any risk of BoP crisis.
For long it looked that the French argument was strong, and Triffin paradox was hyped. However, recent data shows clear weakening of the dollar dominance that has set off political dynamics in the US culminating in some knee-jerk reactions that will leave everyone worse off.
Worldwide, the proportion of allocated foreign exchange reserves held in US dollars has come down from about 72 per cent in 2002 to 57.3 per cent at the end of 2024, partly due to the emergence of the Euro, which currently enjoys a 20 per cent share. However, reserve composition has also diversified to some other non-traditional reserve currencies, including Chinese renminbi, which has a meagre 2.2 per cent share.
Yet, if the US thinks it pays the Triffin cost of supplying the reserve currency, then why is it so worried about emerging threat to dollar dominance and is out to threaten BRICS with 150 per cent tariff on its move for alternate payments system?
Dollar invoicing
Standard open-economy macroeconomic analysis was misplaced. It was believed that export prices are set in the producers’ currency. Starting 2015, Gita Gopinath has advanced dominant currency pricing paradigm noting that the dollar’s share in invoicing was 4.7 times its share in world imports and 3.1 times its share in world exports.
The paradigm suggests that exchange rate pass-through in import and export prices is higher in case of dominant currencies than in other currencies. This will tempt the Trump administration to weaken the dollar further.
However, more recent IMF data shows that dollar is also losing some sheen as a vehicle currency in which trade is invoiced with the Euro and renminbi offering some alternative.
There are clear privileges for the dollar as the reserve currency despite the cost of Net International Investment Position (NIIP). At the end of 2024, the US had a NIIP deficit of $26.2 trillion with total liabilities of $62.1 trillion. Its income surplus in BoP has vanished.
Ordinarily, if this was a debt the US owed in another currency, the weakening of the dollar would have increased its liabilities. However, it enjoys the exorbitant privilege of being able to gain in trade competitiveness without adding to its debt.
So, the US loves multi-currency accords. It sees the Plaza Accord of 1985 that weakened the US currency and the Louvre Accord of 1987, which then halted the weakness, as successful approaches.
The strategy won’t necessarily work as seamlessly as the US thinks it might. Any Plaza type accord at Mar-a-Lago will also mean less dollar buying intervention by central banks. This, in turn, will mean that central banks’ demand for US Treasuries will fall at a time when the impending growth slowdown will whittle down Asia’s saving glut. The non-linearities in financial markets can then completely offset the expected gains from rolling over the US debt at low interest rates in a recessionary environment.
There is some risk of an interest rate shock for the US on the back of tariff kindled high inflation and fall in demand for US Treasuries, especially if the US fails to compress its fiscal deficit with an already high public debt to GDP ratio of 122 per cent. If this happens, US economy may enter an extended stagflation and global markets will be vulnerable to a crisis.
The writer is Professor at IIM Kozhikode and a former RBI ED and MPC member. Views are personal
Published on April 7, 2025
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