Trump's policies are unfavorable to the US dollar? In fact, the US dollar's weakness is imminent

The probability of Donald Trump, the Republican presidential candidate, being elected as the next president of the United States is increasing, and the market's attention to his policies is also growing. Analysis suggests that one of Trump's most potentially influential policies is to promote exports by devaluing the US dollar. However, even before Trump takes office, it is already expected that the dollar will weaken in the coming months and years.

A post on the financial blog ZeroHedge points out that structural overvaluation, years of loose fiscal policy, and insufficiently tight monetary policy make the path of the dollar weakening the least resistant. Moreover, the active devaluation of the dollar carries risks for the United States, other countries, and the global financial system.

The article believes that while financial markets have been indifferent to politics for a long time, the situation has changed. Markets now must closely monitor every word from leaders and their followers. With the increasing likelihood of Trump returning to the White House, the market has carefully studied the policies he has proposed, with the most likely to have a profound impact being the policy of Robert Lighthizer, who is expected to serve as the US Trade Representative during his tenure, planning to promote US exports by devaluing the dollar.

However, the article notes that it is important to be aware that unless there is a radical and unexpected tightening in fiscal and monetary policy in the near term, the weakening of the dollar has become a fact, even with some time remaining before the next president takes office.

The article points out various signs of dollar depreciation in recent times. Firstly, almost every currency in the dollar index (DXY) basket is undervalued based on purchasing power parity (PPP), especially the euro and the yen. Currencies tend to move towards their fair value rather than remain overvalued or undervalued, which will translate into a long-term weakening of the dollar over the next decade.

Secondly, the dollar is also overvalued based on the real effective exchange rate (REER). REER is the bilateral average of exchange rates weighted by the trade volume with each trading partner, adjusted for inflation differentials. The US REER is nearly two standard deviations above its long-term average, ranking fourth globally in terms of stretched levels.

Although the market expects Trump to bring about looser fiscal and monetary policies, such policies have already been initiated. Last year, the US fiscal deficit reached $1.7 trillion, the largest budget deficit in peacetime and non-recession periods, signaling the upcoming weakening of the dollar. Forecasts suggest that deficits typically lead to a weakening of the dollar within 18-24 months.

The Congressional Budget Office projects that regardless of who the next president is, the US fiscal deficit will approach $1.9 to $2 trillion by 2026, with no signs of relief. It is important to note that the Congressional Budget Office typically underestimates annual deficits in the post-financial crisis era The article argues that, in practice, when government spending occurs while the Federal Reserve increases the money supply, it will lead to inflation that devalues the US dollar. The independence of the Federal Reserve has been gradually eroded in recent years, as large fiscal deficits limit the Fed's policy flexibility.

If Trump wins a second term, it is expected that the White House will further encroach on the Fed's policies. Trump has already stated that if Chairman Powell does the "right thing," he can complete his entire term; however, whether Powell is willing to do so is another matter.

To promote the devaluation of the US dollar, there are many ways to do so. The method favored by Lighthizer seems to be to use tariff threats to force other countries to appreciate their currencies. But if the Fed is allowed to implement overly tight monetary policies, this will be meaningless. Currently, the Fed is eager to cut interest rates, even though the economy is still relatively strong, with inflation at 3% and the risk of a resurgence.

Once rate cuts are initiated, it may further exacerbate price pressures, keeping the real yield curve flat, showing how inflation effectively weakens the dollar. This curve is one of the few leading indicators for the dollar in the short term (and very few), indicating that the dollar may weaken in the near term (6-9 months). The US dollar index fell by 1.9% in July.

A flat or inverted real yield curve indicates that for foreign buyers, the attractiveness of US treasuries and other US assets after hedging the actual cost of foreign exchange is reduced, thereby reducing demand for the dollar. Higher inflation may further invert the yield curve.

Analysis suggests that although increasing US net exports in the short term may successfully devalue the dollar, this policy comes with significant risks. First is inflation, including import inflation, but also inflation caused by currency devaluation. Then there is the risk to global growth, as other regions of the world need to adjust, with the US no longer being the global end consumer and having the largest trade deficit, which will in turn affect the US.

If international reserve managers and other holders believe that the US is intentionally devaluing its currency, this poses significant risks to US treasuries, threatening global interest rates and financial system stability. As some experts have pointed out, "the issue is not that the dollar is the main reserve currency, but that US treasuries are the main reserve asset in the world."

The article believes that given these risks, and the difficulty of devaluing the dollar without restricting the US capital account, even if Trump is re-elected, he will not implement the radical policies desired by his trade advisors and campaign partner JD Vance. Of course, if the Trump administration introduces harmful tariffs that affect production efficiency and global and US growth, or if sustained geopolitical risks trigger a demand for safe-haven assets in the dollar, the dollar may strengthen. However, other than that, the weakening of the dollar is already a fact in the coming quarters.