Donald Trump’s focus on the US trade deficit has led him to blame countries with large surpluses, such as China and Germany, for what he sees as unfair competition that harms American interests.
Trump believes that protectionist measures and tariff barriers are necessary and effective tools to rebalance bilateral trade. However, the trade war he initiated during his first term demonstrated the limitations of this strategy. Despite expectations, the US trade deficit did not shrink; instead, it widened. While tariffs can slow imports temporarily, they do not address the underlying issue: a persistent domestic savings shortfall. As a result, the United States continues to rely on foreign savings to maintain its standard of living.
The United States’ budget and external deficits have so far been financed without significant difficulty, largely due to foreign investors’ ongoing demand for dollar-denominated assets. As the issuer of the world’s primary reserve currency and provider of risk-free assets like Treasuries, the US occupies a central position in the international monetary system. This status supports global demand for dollar reserves and allows the US to borrow from foreign investors at favorable rates—a situation described as the “exorbitant privilege” of having the world’s reserve currency.
However, this system depends on continued confidence in dollar-denominated assets. This confidence can be affected by shifts in investor sentiment, which may be influenced by political instability, concerns about a potential budget crisis, or doubts about US institutional credibility. If confidence weakens, investors may avoid US assets or demand higher risk premiums, which could undermine the US’s ability to borrow at low cost in international markets.
Reactions to recent tariff announcements on “Liberation Day” illustrate these risks. Normally, dollar assets are seen as a safe haven during uncertainty, leading to a stronger dollar and lower interest rates. This time, however, the dollar weakened and bond markets tightened, signaling the start of investor anxiety. This distrust is concerning given the unpredictable nature of Trump’s policies, which do not foster a stable climate of confidence. It is also notable that about one third of market-traded US debt is held by foreign investors, making any shift in sentiment potentially significant.
Investors have also been troubled by Trump’s repeated criticism of the Federal Reserve’s independence. Political pressure on monetary policy could undermine its credibility, especially if it results in artificially low interest rates that do not reflect economic conditions. This could lead to rising inflation expectations and prompt investors to seek higher returns to compensate for potential losses in bond value.
Additionally, Trump’s support for a weaker dollar—guided by economic adviser Stephen Miran, now a member of the Fed’s Board of Governors—could threaten the dollar’s role as the foundation of the international monetary system. The proposed Mar-a-Lago Accord, modeled after the Plaza and Louvre Accords of the 1980s, seeks to engineer a weaker dollar while encouraging official creditors to buy zero-coupon 100-year Treasuries. Such measures could be viewed as a form of covert debt restructuring, reducing the appeal of dollar-denominated assets.
If foreign creditors feel pressured by US financial policies, they may become less willing to finance US budget deficits at low cost. Higher risk premiums could threaten debt sustainability and force difficult policy decisions. While there is currently no clear alternative to the dollar as a global reserve currency, history suggests that this position is not guaranteed indefinitely.
“Donald Trump would do well to meditate on the commonsense principle that it’s always best to stay on good terms with one’s banker.”