Donald Trump and the almighty dollar

In a recent interview with Larry Kudlow, the former President Donald Trump asserted that the dollar is losing its dominance as the world’s international reserve currency, as the U.S. comes to resemble a third-world country. With characteristic hyperbole, he warned that the dollar’s loss of its reserve status would be worse than losing any war.

Let’s just say that international economics is not one of Trump’s strong suits.

The key point that Trump missed is that, for the dollar to lose its dominant status as the world’s reserve currency, it must first lose that dominance to another one of the world’s major currencies. Today, there is no serious challenger to the dollar anywhere in sight.

Is Trump suggesting that the dollar will lose its coveted dominant reserve currency status to the Chinese renminbi, given all of China’s present economic travails? Perhaps he is thinking about the Euro replacing the dollar, at a time when the Eurozone economic periphery is drowning in debt? Or how about the Japanese yen or the pound sterling, which belong to countries known for their unusually sclerotic economies and poor public finances?

Trump is not necessarily wrong about the U.S. having troubling economic fundamentals that must be corrected. For example, our unhealthy large budget deficit is placing our public debt on an unsustainable path. It is also contributing to a chronic external account deficit that we cannot expect foreigners to finance indefinitely.

As the Fitch rating recently reminded us, our public finances have reached their current sorry state as a result of the absence of any serious constituency on either side of the political aisle to bring our budget deficit to a more sustainable level. When Trump was in office, he and Republicans choose to cut taxes without making corresponding public spending cuts. And Democrats, as exemplified by the current Biden administration, typically choose to ramp up public spending on a grand scale without daring to raise taxes accordingly to pay for the largesse.

But as bad as our economic fundamentals might be, anyone thinking that our main economic competitors are in a position to replace the dollar has simply not been paying attention.

Take China, the world’s second largest economy. Until recently, it was widely expected to eat our economic lunch. That has certainly changed. There is now every indication that China’s outsized property and credit market bubble is bursting. It also seems that its export and property-led economic growth model has long since passed its sell-by date.

A number of China’s large property developers are teetering on the brink of bankruptcy. House prices are falling in a market now characterized by literally millions of unoccupied dwellings, and new housing starts are slumping. As if that were not enough, China’s economy is now being run by an increasingly erratic Xi Jinping, as underlined by his botched economic management of the COVID crisis and by his heavy-handed clampdown of his country’s high-tech sector.

All of this is giving rise to widespread suggestions that China could be on its way to a Japanese-style lost economic decade. It is also forcing the Bank of China to cut interest rates in an effort to support the economy at a time when U.S. interest rates are at their highest level in decades. This is hardly the stuff of which a serious competitor to the U.S. dollar’s hegemony is made.

The near-term chances of the Euro supplanting the dollar as the world’s dominant reserve currency seem equally far-fetched. It is not just that the Eurozone is now on the brink of a recession and has a worse inflation problem than we do. Rather, it is that its economic periphery — most particularly Italy — has a worse public debt problem today than it had at the time of the 2010 Eurozone sovereign debt crisis.

Especially at a time of recession, the Eurozone’s debt problems have to raise serious questions about the Euro’s long-term survivability in its present form. That hardly makes it a serious candidate for replacing the dollar.

If the basis for Trump’s claim that the dollar is about to lose its dominant role is flimsy, the timing of his claim could not be worse.

Next year, we could have real strains in the world financial system, be it from a deepening of the current Chinese economic crisis, a renewed round of the Eurozone debt crisis, or a wave of debt defaults in the commercial property and highly leveraged loan space. If that were to occur, the dollar would likely soar as investors would seek, as they traditionally do, the safe haven of the U.S. dollar and our country’s deep financial markets.

Desmond Lachman is a senior fellow at the American Enterprise Institute. He was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.