Trump’s attacks on the Federal Reserve risk fuelling US inflation and ending dollar dominance
US president Donald Trump’s attacks on the chairman of the Federal Reserve, Jerome Powell, are yet another signal of a new era of economic policymaking and governance.
After repeatedly calling Powell “stupid” for not lowering interest rates quickly enough, Trump has now directed government prosecutors to launch a criminal investigation into Powell for allegedly misleading the Senate about the costs of renovations at the central bank’s buildings, allegations he denies.
While the immediate risk of forcing an interest rate cut too quickly would be higher inflation in the US, Trump’s unprecedented attacks on Powell cannot be seen merely as a domestic matter.
This is not just because of the US economy being the largest in the world, but also due to how businesses, consumers and governments use the US dollar in their economic affairs.
Since the 1980s when Trump was a celebrity businessman, he has been making his vision of economics clear. Now, as the most powerful man in the world, he is trying to put that vision into practice.
In this vision, there are clear winners and losers in any economic transaction. And instead of mutual benefits, the US must always be the winner.
While the fairness of trade relations is always open to academic and political scrutiny, the global economic order after the second world war has had a way of resolving disputes through bodies like the World Trade Organisation.
A rule-based international trade regime helped to generate spectacular economic growth in the second half of the 20th century. Yet, the start of the 21st century hasn’t been great for the world economy, with two major financial crises in the early 2000s (the dotcom bubble and global financial crisis).
Added to these are the rise of populist and authoritarian politics and the COVID pandemic. These have shifted the ground on which the rule-based global economy had been thriving since the 1950s. Threats to that world economic order also threaten the pre-eminent place of the dollar within it.
The US dollar was the official reserve currency of the world economy between 1944 and 1976 through international agreements backed by gold reserves. International trade imbalances, which initially favoured the US but then benefited the fast-recovering European and Asian economies, put an end to this gold standard.
Yet, because of what some scholars call path dependence (where society tends to stick to familiar processes), the dollar has continued to act like the world’s reserve currency.
Advances in finance theory and practice, such as new valuation models and increased computing power, have also helped businesses and governments manage their affairs in this deregulated yet highly integrated economic environment.
The autonomy question
Another important factor in the dollar’s dominance has been the strength of institutions, including the rule of law in the US. A pinnacle of this is the Fed, and its autonomy over monetary policy to ensure maximum employment and price stability in the US economy.
This autonomy is enshrined in the US constitution and many developed and developing countries followed suit and gave policy autonomy to their central banks. This was often after turmoil caused or exacerbated by politicians. Since the 1980s, the Fed has been the most important source of economic information for business, investors and governments around the world.
But now Trump is threatening to reverse this autonomy and replace it with his own vision of economics involving lower interest rates to boost economic activity and decrease government debt payments.
It’s possible that Trump may be following the lead of Turkish president Recep Tayyip Erdoğan, who put his country’s economy in negative interest rate territory in 2019. This was followed by soaring annual inflation, which some commentators calculated to be in triple digits.
Any politically driven cut in interest rates in the US, ushered in with a new Fed chairman (Powell’s term ends in May) will almost certainly lead to inflationary pressures. This is because it will trigger consumer borrowing and consumption, especially if people realise how the value of their dollars is deteriorating compared to goods, services and other currencies.
This can become a vicious cycle, where inflation gets out of control and US consumers avoid holding dollars. They may seek alternatives like gold and cryptocurrencies until a more orthodox monetary policy is adopted again. Of course, Trump is now a champion of cryptocurrencies, after once likening bitcoin to a “scam”.
None of this fits well with Trump’s election promise to bring down consumer prices.
Global trust and interest in US assets are already declining, as many investors are openly or anonymously (for fear of retaliation by the Trump administration) discussing their growing aversion to the US economy. This does not help the dollar. A depreciated and politically controlled dollar would likely herald the beginning of the end of dollar hegemony.
Over the years, commentators wrongly announced the beginning of this decline after events such as the introduction of the euro and moves by China to foster a new global monetary system. But these ignored how path dependence and inertia in economic affairs reduce uncertainty and can underpin a currency’s status as a reserve currency.
Yet, if Trump and his successors realise their economic vision, the world might finally see a real reversal in the dollar’s fortunes. This could come alongside increased economic regionalisation determined by the “us against them” mentality.
History teaches how such episodes led to open conflict – and how the world once managed to prevent them with a rule-based international order.
Emre Tarim does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.