The Plumbing Of Global Finance May Be Changing - Can The Dollar Keep Up?
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Recent shifts in global financial dynamics have raised critical questions about the future of the U.S. dollar’s dominance.
In "Trump's New World Order Tests the Dollar," the WSJ barely scratches the surface. The deeper issue is whether the very plumbing of global finance is shifting in a way that could threaten the dollar’s reserve currency status.
In this context, let’s explore how these changes are influencing the dollar’s role in the global economy.
The U.S. Functions Like a Hedge Fund
Think of the U.S. financial system as a bank—or a hedge fund. Investors borrow in USD to seek higher returns abroad, a strategy used by both domestic and foreign investors.
When foreign investors borrow in USD, it’s effectively a short position on the dollar.
But when risk sentiment turns negative, a de-leveraging may be at play, causing a short squeeze—a side effect of which is that the dollar rises.
Fragility in Emerging Markets
Dollar rallies destabilize markets with weak financial structures that have borrowed in USD. The underlying fragility is already there—a stronger dollar just exposes it.
In my assessment, The best long-term solution is to develop stronger domestic capital markets.
But that’s easier said than done.
The ‘Exorbitant Privilege’ Faces Pressure
Being what amounts to the world’s financial anchor gives the U.S. an “exorbitant privilege”—the ability to run larger deficits than other nations without immediate consequences. This is, in part, because of the depth of U.S. capital markets and the global reliance on the dollar.
A crack in this structure appeared when the U.S. began weaponizing the dollar through sanctions. This has given foreign players an incentive to diversify their reserves, potentially challenging the dollar’s dominant role.
Is Gold Sending a Warning?
The weaponization of the USD isn’t just an abstract idea—it’s showing up in the markets.
The breakdown in the correlation between gold and long-term real interest rates is a sign of shifting dynamics. While the relationship was never perfect, gold tends to compete with cash—when cash preserves its purchasing power, there’s less need to hold gold. In my analysis, the correlation has broken down—a development that may point to deeper shifts underway.
A New Doctrine, A Fragile System
Trump has long argued that when there’s a trade deficit, the U.S. is being “ripped off.” If tariffs were merely there to raise taxes, we might expect a short-term bump in inflation and a slightly less efficient economy. However, tariffs appear to be aimed at eliminating trade deficits — keep in mind that Trump already complained about trade deficits in the 1980s.
In an expansive interpretation, this could disrupt the financial system that has long facilitated global trade and capital flows.
At the core of this is how the current account works: it tracks exports minus imports of goods and services, along with net income and transfers. It balances with the financial account through capital flows. If exports minus imports equal zero, the U.S. isn’t borrowing or lending internationally.
This system has allowed the U.S. to finance deficits through foreign capital flows. Changing it may come with unintended consequences.
When Foreigners Stop Financing U.S. Deficits
If foreign countries stop 'ripping off' the U.S., in Trump’s terms, they may also stop financing U.S. deficits. This isn’t a political argument—it’s simply how the current account works. The goal may be to achieve more balanced trade, but be careful not to put the cart before the horse.
For decades, the U.S. has relied on foreign capital to help fund its deficits. If that support erodes, the U.S. may have to adjust—either by cutting spending, raising domestic savings, or finding new sources of financing. The transition won’t necessarily be smooth.
Trumponomics and the Budget Reality
Trumponomics would work if the U.S. runs a balanced budget.
Trump recently stated this as a goal in his address to Congress.But so far it appears to have largely been written off as aspirational at best.
Yet, as we’ve seen before, be careful dismissing Trump’s statements too quickly.
Caution: Just because something can’t pass through the budget process in Congress doesn’t mean Trump won’t try to implement it through executive action.
The Shock Treatment Approach
Treasury Secretary Bessent has said that the U.S. economy may need to endure short-term pain.
Translation? Rebalancing the global economy is a priority—and the administration isn’t afraid of shock treatment.
Can the System Withstand the Shock?
A shock treatment approach may prove to be a greater shock than the system can handle.
If the market has less of an appetite to finance deficit spending, markets could react sharply.
And suddenly, pressure on the Federal Reserve to lower rates may not seem so outlandish.
Even an ‘Independent’ Fed May Respond to Pressure
History shows that when push comes to shove, even a so-called independent central bank may step in to finance the government.
During and after WWII, the Federal Reserve was pressured to keep rates low to finance war debt and support recovery. It wasn’t until the Treasury-Fed Accord of 1951 that the Fed regained its independence, ending the policy of artificially low rates.
As Mario Draghi once put it: the central bank will do “whatever it takes.”
Should the Market Be Reacting More Than It Is?
If my analysis is correct, we should already be seeing greater disruption in the markets.
That could mean one of two things:
- This framework is wrong, or
- The market hasn’t caught on yet.
The Next Phase of Instability Is Here
The world isn’t black and white.
Yes, the administration has aspirational goals, but there are institutional barriers to executing this rebalancing. To the extent that the administration succeeds, expect an incremental shift—not a clean break. And don’t expect a linear implementation. Trump is transactional, not dogmatic—which means we should expect: Two steps forward, one back, one sideways.
Won’t the U.S. Just Start Producing More?
Some argue that if foreign financing dries up, the U.S. will have to produce more and trade goods rather than relying on dollars created out of thin air.
Sure, but in a credit-driven world where governments—both in the U.S. and abroad—have failed to get their books in order, such a shift could trigger major financial stress and economic dislocation.
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