The Age of a Treacherous, Falling Dollar: A New Reality for Global Investors
Over the past year, President Donald Trump has aggressively imposed tariffs on allies, pressured the Federal Reserve, and dismissed budget deficit concerns. Yet, most asset markets have continued to perform strongly, with the S&P 500 index rising 14% as investors flock to artificial intelligence (AI) opportunities. America's economic growth remains the envy of the world, and the ten-year Treasury yield stands at 4.3%, lower than when Trump took office.
A Darker Picture Emerges
However, a closer look reveals a more complex and troubling scenario. Since peaking in January 2025, the dollar has plummeted by 10% against a broad basket of currencies. This decline has severely impacted the performance of American assets in foreign-currency terms. For instance, when measured in euros, American stocks have shown minimal growth over the past year.
The currency's fall is partly attributed to the narrowing interest-rate gaps between America and the rest of the world. Yet, American institutions have also become a source of anxiety. Investor panic has become more frequent, such as in April 2025 following Trump's "Liberation Day" tariffs announcement. During these episodes, investors flee American assets, causing bonds, stocks, and the dollar to lose value simultaneously.
This phenomenon, once common in emerging markets, has occurred seven times in the past 52 weeks—roughly three times more often than in the previous decade. While normalcy returns when Trump retreats from extreme policies, these spasms offer glimpses of a topsy-turvy world where dollar assets are no longer a safe haven.
Alarming Implications for the Global Economy
This prospect is particularly alarming given the dollar's role as the world's reserve currency. Foreigners own more assets in America than Americans own abroad, amounting to 89% of the U.S. GDP. Concurrently, gold prices have surged to around $5,000, marking a 75% increase in a year. This spike fuels speculation that investors are hedging against dollar debasement and other tail risks, challenging the notion of America's unbreakable financial strength.
A recent example of apparent normalization was Trump's January 30th announcement nominating Kevin Warsh to lead the Federal Reserve. Warsh, an experienced central banker with Wall Street connections from the 2007-09 financial crisis, is known for his hawkish monetary policy stance. His nomination triggered a dollar rally and a drop in gold prices, offering temporary relief.
Underlying Volatility Persists
Despite this, the broader trend remains concerning. Over the past month alone, as Trump threatened Greenland, the greenback fell by 1.5%, while gold rose 14%. Warsh, despite his hawkish history, has shifted toward advocating interest-rate cuts to align with Trump's agenda. He argues that AI-driven productivity booms will enable fast growth with falling inflation and that the Fed can offset rate cuts by shedding long-dated assets.
However, these arguments face scrutiny. The AI frenzy, if sustained, could lead to higher interest rates due to increased investment and consumer spending, similar to the dotcom boom of the 1990s. Moreover, Warsh's past warnings about asset purchases causing inflation were inaccurate, and offloading assets now would have minimal disinflationary effects.
Risks of Ill-Timed Policy Moves
If Warsh, once confirmed, pushes for significant rate cuts, they may prove ill-timed. America's inflation rate is 2.8%, still above the 2% target. This year's tax cuts and potential refunds from overturned tariffs could provide a fiscal stimulus of up to 0.8% of GDP. Combined with monetary easing, this could fuel higher inflation, further undermining confidence in dollar assets.
How far can America push its luck? The country benefits from a lack of alternatives to the dollar; precious metals are poor substitutes, and no bonds match Treasuries in volume, liquidity, and legal safety. Foreigners may shun pricey American equities over bonds, as seen in recent tech stock jitters. While central banks have diversified reserves, the dollar dominates cross-border banking, trade invoicing, global debt, and foreign-exchange deals.
A Long Road Ahead for the Greenback
This dominance offers some protection against a dollar rout, but volatile policymaking and a falling exchange rate have made holding the dollar riskier than in decades. Even if Warsh's inflation predictions are correct, lower interest rates will further weaken the currency. The dollar, despite its recent decline, remains overvalued against most currencies according to metrics like the Big Mac index.
The absence of alternatives forces foreign investors to bear losses, but it should also alert American investors to the potential emergence of a rival currency. Ultimately, the world must confront how an asset once considered a safe haven is now tainted by risks that affect everyone globally.
