In recent months, Donald Trump and others close to him have been linked to calls for dollar devaluation. A chorus of commentaries, here and among many foreign exchange market participants, have cast doubt on the feasibility of devaluation and argued Trump’s economic policy orientation could achieve opposite results. Others suggest the dollar may soon start depreciating, vindicating Trump and his team’s desire for a weaker dollar.
‘Depreciation’ and ‘devaluation’ both entail a lower dollar. But there are critical distinctions between the two. Don’t confuse them.
The dollar’s value in foreign exchange markets fluctuates. It appreciates and depreciates – that’s the way floating exchange rates work. Around the time of the 2008 financial crisis, it took nearly $1.6 to buy €1; now it takes $1.1.
The trade-weighted dollar is now extremely strong, propelled higher by large capital inflow, associated with US outperformance, fiscal pressures on yields and, critically, the Federal Reserve’s rate hiking campaign to combat inflation (Figure 1). From a trade or current account standpoint, the dollar is clearly overvalued.
Figure 1. The dollar is clearly overvalued from a trade perspective
Source: US Federal Reserve
The US economy is now slowing. America is emerging victorious in its battle against inflation. Markets believe the Fed will soon start cutting rates, continuing into 2025. Since the end of April, 2- and 10-year Treasury yields have fallen by 60 and 40 basis points, respectively.
Though predicting exchange rates is a fool’s errand, the expected rate path may contribute to curbing dollar demand, taking the dollar off its highs. Hence, on the back of expected Fed cuts, dollar depreciation may well be in the cards.
But a call for devaluation should not be confused with depreciation. ‘Devaluation’ suggests not that markets will do what markets do, but that it would be official US policy to take active steps to lower the dollar.
Of course, devaluation took place under the Bretton Woods System of fixed but adjustable exchange rates, when the US devalued the dollar in December 1971 and February 1973. But the US and major countries thereafter began floating their exchange rates.
Calls for devaluation are at times posited in opposition to past US ‘strong dollar’ policies. That policy was adhered to by the Bill Clinton, George W Bush and Barack Obama administrations. Over the years, Treasury secretaries learned not to speak about the dollar’s value for the justifiable fear of triggering market instability and undermining the Secretary’s credibility. Thus, the ‘strong dollar’ mantra developed a Potemkin village quality in seeking to avoid a cat-and-mouse barrage of media inquiries.
But, had secretaries spoken freely, they might well have said that the dollar’s value and global reserve currency role reflects the health of the US economy, and the ‘strong dollar’ meant the US should pursue sound economic policies at home. This issue is well discussed in ‘Paper Soldiers’ by Saleha Mohsin.
Don’t shoot the messenger
Some devaluation proponents may be inclined to blame dollar strength for trade deficits and/or job losses. But many job losses reflect technological change, shifting consumer appetites and globalisation, not exchange rates.
Dollar strength also results from imbalanced US macro policies. Blaming the dollar can thus be akin to shooting the messenger. Further, as the adage goes: one can’t devalue one’s way to prosperity.
Devaluation would fly in the face of the longstanding G7 and G20 commitments not to target exchange rates and to pursue exchange rate flexibility. It would counter the G7 approach to orientate policy towards domestic objectives using domestic instruments. Those commitments were forged by the US, especially in response to harmful foreign currency and external practices that resulted in persistently undervalued currencies and/or massive current account surpluses. In calling for devaluation, the US could be accused of fomenting currency wars and doing exactly what it has long exhorted others not to do.
The dollar’s global dominance rests on the strong properties of the US economy – its size, the depth, liquidity and openness of its capital markets, its strong financial system and rule of law, and America’s geopolitical role as a trusted partner. Calling for devaluation could be perceived as potentially bringing those very properties into question and as being inconsistent with the promise of the Republican party platform to ‘keep the US dollar as the world’s reserve currency’. Calling for bitcoin to become an alternative reserve asset to the dollar also seemingly comes up against that promise.
As discussed by OMFIF in May, long before the recent rash of news stories, an even more expansionary fiscal policy and tariffs – as suggested by Trump’s plans – would support a stronger, not a weaker, dollar. Further, a devaluation policy could entail taking actions that might simply not work (Figure 2).
Figure 2. Potential devaluation policy actions
| Devaluation approach | Flaws |
| Talk dollar down | At best a short-lived impact. Macro policy unchanged. Creates market volatility. |
| Unilateral US intervention | US intervention resources likely to be limited unless Fed prints dollars/Treasury takes extraordinary measures. Creates market volatility on G7 discord. Foreign exchange market volume is in trillions daily, meaning it is hard to impact. |
| Modern Plaza Accord | Would the European Central Bank or Japan sign on? G7 has long pledged not to target exchange rates. Fed is independent and has domestic mandate. Doubtful that US can make credible fiscal commitments. |
| Fed cuts | Fed is independent and has domestic mandate to focus on price stability/maximum employment, not to target dollar exchange rate. |
| Act to slow/halt capital inflow | Could upset financial markets and lift US yields. Undermines US openness, which is a key pillar of dollar reserve currency role. |
In short, a policy of devaluation may not only be infeasible, but it could be injurious to the US and global financial markets. The dollar may well move lower on the back of Fed rate cuts. But ‘depreciation’ and ‘devaluation’ are different concepts that shouldn’t be confused or conflated.
Mark Sobel is US Chair of OMFIF.
