Vivek Kaul: Trump’s tariffs won’t kill the dollar’s exorbitant privilege

Essentially, while other countries have to earn dollars in order to pay for anything priced in the US currency, the US has the option of simply printing them.
Essentially, while other countries have to earn dollars in order to pay for anything priced in the US currency, the US has the option of simply printing them.

Summary

  • Exporters to the US may want to shift trade into other currencies, but we can’t expect the dollar—which America has the privilege of printing—to get dethroned as the currency of trade anytime soon. Old habits die hard.

Aldous Huxley, the English writer and philosopher, once said: “That men do not learn very much from the lessons of history is the most important of all the lessons that history has to teach." This dynamic is currently playing out in the United States.

President-elect Donald Trump has been warning of imposing tariffs on countries with which the US has a trade deficit—that is, countries from which the US imports more goods and services than it exports.

There will be a few obvious effects of these tariffs. From January to October, the US ran a trade deficit of $736 billion, 12% higher than in the same period of 2023.

Imposing tariffs to reduce the trade deficit would require sourcing goods and services locally, which might not be available at the same prices as imported alternatives or in sufficient quantities to meet demand.

 Also read: Ajit Ranade: India needs more sectors to be reliable dollar earners

Goldman Sachs has estimated that tariffs will lead to inflation going up 1%. Further, many American and other companies that import what they sell in the US, from automobiles to household durables, may see their profits fall.

Indeed, the tariff threat may also be about nudging companies to move their sourcing and supply chains out of China. This is something that started during Trump’s first term as US president and continued under Joe Biden.

In fact, in January to October 2022, the US trade deficit (in goods) with China stood at $337 billon. In January to October 2023, it fell to $235 billion. This year, it was at $245 billion, implying that the US has seen some success on this front.

Of course, any increase in tariffs will come with the average American consumer having to pay higher prices. But then economic decision-making is usually about making trade-offs, and this is a trade-off that Trump, his administration and their supporters may be ready for in order to ‘Make America Great Again’ (MAGA).

Further, it’s possible that all the talk about imposing tariffs may be all about drawing countries with which the US runs a trade deficit to the negotiating table (except China).

But there is a much larger point here: the exorbitant privilege of the US dollar. It is currently the world’s reserve currency, which basically means that it is the currency in which countries carry out economic transactions such as exports and imports. As a result, many countries have a large part of their foreign exchange reserves in US dollars.

This gives the dollar an exorbitant privilege. Essentially, while other countries have to earn dollars in order to pay for anything priced in the US currency, the US has the option of simply printing them. As Ray Dalio puts it in Principles for Dealing with The Changing World Order: “The country that gets to print the world’s primary currency is in a very powerful position."

Also read: Mint Primer | Rupee takes a dive, more turbulence in 2025

So, how did the US dollar end up with this privilege? Around the time that World War II was coming to an end, many countries came together to sign the Bretton Woods agreement.

This placed the dollar at the heart of the international financial system, with the US ready to convert dollars into gold at the rate of $35 for one ounce (31.1gm) of it. This made the dollar the premier international currency, as it was the only currency that could be converted into gold.

In the years that followed, a dollar shortage developed because other countries imported far more from the US than they were able to export to it. The US was not able to supply enough dollars to the world market. Only once this shortage ended could the Bretton Woods system be deemed a success.

In the late 1950s, this dollar shortage started coming to an end, at least in Europe. Economic aid from the US was one reason for it. Also, with the Cold War in full swing, the US set up military bases in other parts of the world, spending around $3 billion a year on their operation and maintenance. This ended the dollar shortage and strengthened the exorbitant privilege.

On 15 August 1971, president Richard Nixon ended the conversion of dollars into gold. But the world had by then totally moved on to trading and saving in US dollars. Over the years, these dollars found their way back into the US.

Countries bought bonds issued by the US government and other companies and institutions, and thus helped the US keep interest rates low, which helped Americans consume more and more and led to them living way beyond their means. This, in turn, helped countries export more to the US.

Further, the dollars these countries earned found their way back to the US again, helping keep interest rates low, and so the cycle has worked that way to this day. And for this cycle to continue working, countries need to continue buying and selling things in US dollars.

Also read: Trump’s dollar defence plan: It’ll hurt more than benefit the US

Even if Trump is just bluffing, his threats will incentivize countries that export hugely to the US to start thinking about moving their trade away from dollars. Of course, this won’t happen overnight or even in a few years or decades, but it’s something these countries can gradually keep chipping at.

As Dalio puts it: “The common reserve currency, just like the world’s common language, tends to stick around after an empire has begun its decline because the habit of usage lasts longer than the strengths that made it so commonly used."

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