In light of the potential policies of a second Trump administration, Deutsche Bank’s research department delves into the practical challenges associated with implementing a softer US dollar policy. Analysts highlight the obstacles and constraints to such a strategy and argue that tariffs and their associated stronger impact on the US dollar are likely to dominate market outcomes.
Theoretical impact of weak dollar policy
The US soft dollar policy aims to weaken the dollar, perhaps through intervention or capital controls. This would require massive interventions in financial markets, possibly trillions of dollars, or expensive capital controls. The analysis suggests that a significant depreciation of the dollar, by as much as 40%, would be necessary to close the trade deficit.
Challenges of Unilateral Intervention in the Foreign Exchange Market
Proposals to weaken the dollar include creating a foreign-exchange reserve fund of up to $2 trillion. This approach would require massive additional Treasury debt and create a fiscal burden, perhaps exceeding $40 billion per year in net interest expenses. Such an intervention would likely face significant political and practical obstacles, especially given the scale required. Recent experiences, such as the Japanese Ministry of Finance spending $63 billion in just two days, highlight the enormity of the challenge. Scaling it up to affect the US dollar would require at least $1 trillion, which is not feasible.
Constraints on multilateral intervention
Multilateral intervention is constrained by the G7’s commitment to market-determined exchange rates and the limited foreign exchange reserves of major economies. With the exception of Japan, the G10 central banks lack sufficient reserves to intervene effectively. Historical examples, such as the Plaza Accord, involved much larger reserves and smaller capital markets than the current scenario.
potential capital flows
Encouraging U.S. capital outflows could be another approach to weakening the dollar. Historical attempts, such as Switzerland’s in the 1970s, have shown limited success. Measures such as taxing foreign deposits or introducing residency requirements could be considered, but imposing large-scale capital controls would conflict with Trump’s stated policy of preserving the dollar’s status as the world’s reserve currency.
The erosion of the independence of the Federal Reserve
Erosion of the Fed’s independence would be the most effective way to weaken the dollar, though it remains unlikely. Historical examples, such as the UK crisis in 2022, show how undermining central bank independence can lead to higher inflation risk premiums and higher long-term yields. However, with only a handful of Fed appointments up for renewal and Senate confirmation required, this scenario seems unlikely.
While the Trump administration may put rhetorical pressure on the dollar, major fiscal interventions, capital controls, or the loss of the Fed’s independence will be necessary to implement a weak-dollar policy. Analysts point to tariffs and their impact on the dollar as the most likely outcome.
