In terms of shaking up the global exchange rate system, there is little question that Richard Nixon serves as the closest analogy to Donald Trump in his second term. Nixon’s decision to suspend the convertibility of U.S. dollars into gold on Aug. 15, 1971, upended the global monetary system and presaged a disastrous decade of high inflation, low growth, and the weakening of the dollar as European countries delinked from the U.S. currency. Although the final chapter is yet to be written on Trump’s international economic policies, the uncertainty triggered by his tariff war suggests a high risk that the dollar, inflation, and growth will once again be casualties. This time, it will be a renminbi bloc—China and the many countries for which it is the major trading partner, particularly in East Asia but also in Latin America and Africa—that separates from its tight links to the dollar, with the already existing euro bloc gaining market share at the dollar’s expense. Cryptocurrencies are already eroding the dollar’s preeminence in the underground economy, which represents perhaps much as 20 percent of global income.
To be fair, both Nixon and Trump were facing challenges to the status quo for the dollar even before they decided, each in their own way, to blow things up. When Nixon became president in 1969, the dollar had been riding high for 25 years since the Allied powers agreed to a new exchange rate framework in a historic 1944 meeting in Bretton Woods, New Hampshire. (The meeting also led to the creation of the World Bank and the International Monetary Fund.) Famously, British delegate John Maynard Keynes proposed a supranational currency, the bancor, as an alternative to the dollar but was beaten down by the Americans, who were, after all, holding all the cards given that the U.S. economy towered above all others by the end of World War II.
Instead, the so-called Bretton Woods system placed the dollar at its center and required all other currencies in the system to peg their exchange rates to the U.S. currency. Washington was free to run its monetary policy as it saw fit, with the one giant caveat being that if foreign central banks or finance ministries wanted to tender their U.S. dollar holdings (mostly in the form of interest-paying Treasury bills, not physical currency) for gold at $35 an ounce, the United States had to accommodate them. It should be noted that a large part of the world, including not only communist countries such as China and the Soviet Union but also much of the developing world, stood outside the system.
The arrangement worked remarkably well despite the occasional need for a modest currency realignment as well as recurrent debt crises in the United Kingdom that required a string of bailouts. The major economies prospered. However, the postwar system of pegging the dollar to gold had deep underlying vulnerabilities. As Europe and Japan grew, so too did their need to hold reserves of U.S. dollar assets; they needed the firepower to take on speculators who might try to topple their exchange rate pegs. Although the U.S. government generally obliged by pumping out debt, its gold reserves did not grow at the same clip, implying that the gold backing for the dollar became thinner and thinner. Indeed, Yale University economist Robert Triffin famously predicted in a 1959 congressional testimony that if foreign governments lost confidence in the dollar and started trying to trade in their Treasury bills, the result would be a classic bank run that would blow up the system.
Triffin’s prophecy took more than a decade to unfold, in part because the arrangement was working well for all the major participants and no one wanted to catalyze a breakup. Over time, several factors began to undermine confidence in the system. First, global capital markets started to become ever larger and more liquid, creating a bigger army of private speculators that could potentially gang up against the dollar. Second, and perhaps more importantly, the United States began to experience inflation, which, even though relatively mild, was cumulatively significant since it reduced the purchasing power of the dollar and increasingly made the price that the United States had set for gold seem like a great bargain. (Early this June, an ounce of gold was worth more than $3,300, nearly a hundred times more than the price set under Bretton Woods.)
Still, despite the temptation, foreign governments were reluctant to risk taking down the system, which was otherwise working so well for their economies and people. Several countries, particularly France, did start cashing out their dollars, particularly as it became apparent that the United States, under the strain of paying for President Lyndon B. Johnson’s Great Society welfare programs and the burgeoning costs of the Vietnam War, was struggling to stop inflation from creeping up. Thus, in a sense, Nixon’s decision to euthanize the Bretton Woods fixed exchange rate mechanism was simply giving in to the inevitable. Nevertheless, his timing came as quite a shock, especially as most experts thought the system could trudge on for quite a bit longer.
Having suspended gold convertibility—which eventually led to abandoning it entirely—Nixon sent Treasury Secretary John Connally to Rome to confront his outraged foreign colleagues, who worried that by abandoning gold convertibility, the United States had positioned itself to radically inflate the value of their massive Treasury bill holdings (which is, of course, precisely what happened over the course of the ensuing decade). Connally responded by telling them: “The dollar may be our currency, but it’s your problem.”
Unfortunately, neither Nixon nor Connally quite realized that the shedding of gold convertibility was also very much the United States’ problem. The 1970s was a very difficult period for the country, with growth slowing sharply and inflation sitting uncomfortably in the double digits, at one point reaching 14 percent.
In his second term, Trump looks on track to replicate many of the macroeconomic problems of the Nixon presidency. Trump entered office with a domestic economy that was the envy of the world, despite elevated post-pandemic inflation. Then came his tariff war, not to mention a host of other policies that threaten to undermine dollar dominance. These include weakening the rule of law, eroding U.S. soft power, reducing the United States’ openness to trade, limiting immigration, and attacking research universities, among other things.
On top of the tariffs, Stephen Miran, the head of Trump’s Council of Economic Advisers, has put out a blueprint for a so-called Mar-a-Lago accord, in which one component involves having foreign governments accept hundred-year “discount” bonds that pay no interest until maturity, in what would amount to a major sovereign default. No matter what interest rate the United States set on the bonds, foreign governments would rightly worry about inflation just as they feared when Nixon went off the gold standard five decades ago.
The Mar-a-Lago plan will likely never happen; many say it is too extreme. Given other conventions Trump is breaking, though, can one honestly counsel foreign central banks—which hold trillions of U.S. dollars in foreign exchange reserves—not to hedge their bets?
To be fair to Trump, the dollar’s dominance was already fraying at the edges by the time he returned to office. As I emphasize in my recent book Our Dollar, Your Problem, Chinese decoupling from the dollar began in earnest in 2015 and in recent years has accelerated.
The deepest vulnerabilities, however, come from within. The U.S. debt trajectory has become conspicuously unsustainable now that long-term interest rates have inevitably risen from their post-financial crisis lows. With little apparent appetite in either political party to rein in debt, one strongly suspects that nothing will happen until there is a crisis that jolts the public into realizing the full dimensions of the problem. Remarkably, after Trump lashed out at President Joe Biden’s record 6.4 percent of peacetime GDP deficit spending (outside of 2008 and 2020, when the global financial crisis and COVID-19 pandemic hit, respectively), his deficits look set to be over 7 percent for the rest of his term, even absent a deep recession or another shock of pandemic proportions. With U.S. debt levels already exceeding 120 percent of income, future budgets are extremely sensitive to the considerable risk of further rises in interest rates from the ultra-low levels after the financial crisis. If foreigners pull back, and global demand for U.S. assets falls, the effect will be to push up interest rates and make the U.S. debt situation even more unsustainable. While a crisis, likely involving another big burst of inflation or growth-stifling financial repression, is not inevitable, the odds have been rising sharply and now seem more likely than not over the next four to five years. It took a decade to stabilize the U.S. economy after Nixon. Will the same be true for Trump?
The post Trump Is Accelerating the End of Dollar Dominance appeared first on Foreign Policy.
