Is the Damage to Dollar’s Status permanent?

Key Takeaways

• The tariff policies of President Donald Trump and his attacks on the Federal Reserve have raised doubts about whether U.S. assets will be as safe as in the past.
• This threatens the dollar's status as the most widely used currency in global trade and weakens the dollar against a basket of foreign currencies.
• Analysts, however, say that it’s unlikely that the dollar’s position in the global economic system will change significantly.

Wall Street continues to wonder, as investors recover from a volatile tariff month, how much the U.S. currency’s status has weakened. 

Analysts say that “King Dollar” will not be dethroned any time soon due to the lack of an alternative. The dollar has been the most widely used currency for global trade since World War II. Previous efforts to replace the dollar have failed.

Despite this, President Donald Trump’s policies on tariffs and his attacks against the Federal Reserve have sown uncertainty in global financial market, fracturing this dominance. While he has since eased off on both counts, and U.S. stocks have recovered somewhat, the doubts among investors around the world don’t seem like they are going away.

In a note sent to clients last weekend, Morgan Stanley strategist Vishwanath TIRUPATTUR wrote: “It’s hard to put the bottle back in the genie once such concerns have been raised.” 

He wrote that “practical realities will make it hard to massively change the dollar’s position.” 

The Dollar Could Just Be Facing Temporary Weakness…

As the dollar is an integral part of global commerce, many countries and central banks have large amounts of dollars stashed away. According to the International Monetary Fund (IMF), the U.S. Dollar accounted for 57% of foreign currency reserves in the past year. This compares to 20% for Euros, 6% for Japanese yens, and 5% for Pound Sterlings.

According to the Bank for International Settlements, the U.S. Dollar will be involved in 90% of the transactions on the foreign currency market in 2022. This is where investors and companies exchange foreign currencies.

Brent Coggins said there is “really” no alternative to the dollar. Brent Coggins was chief investment officer for Triad Wealth Partners based in Kansas. The Euro is “very fractioned”, China’s money doesn’t float on the market and the yen has “no scale” to compete with it, he said.

Dollar dominance has long irked some countries—and not just those subject to U.S. sanctions such as Russia or Iran. In the 1960s a French official called the dollar’s dominance an “exorbitant priviledge” for the United States. This moniker has stuck ever since.

More recently, the BRICS countries—which include Brazil, Russia, India, and China—have reportedly dropped the idea of developing a common currency even as they seek to bolster their local currencies in trading arrangements rather than the U.S. dollar. Coggins said that the dollar has outlasted several other alternatives.

Coggins stated, “Even if it is currently going through a disruption, and people are challenging the system, it has always been able to overcome challenges and come out ahead.” “We don’t think this will be any different.”

…But It Still Faces A ‘Confidence Crisis’

Arun Sai is a senior multi-assets strategist at Pictet Asset Management in Europe. 

Investors are questioning whether U.S. Treasury bonds—which the government issues to finance its deficits—are still the “safe haven” they used to be. Investors are also selling some of their U.S. stock holdings, with tech companies being hit hard and concerns over the U.S. economic outlook clouding the outlook for other stocks.

The dollar has weakened by 8% this past year against a basket made up of foreign currencies due to the selling of U.S. Dollar assets.

Some analysts believe that the worst is over. Wells Fargo international economic Nick Bennenbroek wrote that the dollar’s decline was “atypical” and “likely temporary” in a recent research note. 

Sai believes that the U.S. financial market and its “absolutely outstanding companies” are still worth investing in. However, global asset management firms like Pictet have re-evaluated their heavy U.S. exposure and are considering alternatives. Some are investing in gold, which has reached record highs. German bonds also make a good option for those who are looking for a safe place to invest. Emerging markets also see inflows.

Sai said that Trump’s policies “have incentivized the capital to stay home.” Sai said that when he is looking to deploy his cash, he weighs assets in Europe and Britain “a little more than I would last year.” 

Analysts said that this could change.

Bennenbroek wrote, “We certainly understand the financial markets’ interest in reallocating away U.S. Assets at this particular moment. But we ultimately think that this shift is more tactical than a fundamental assessment of U.S. Assets.”