Why is it not so easy for Trump to "weaken the US dollar"?

One of the most market-focused policies of Trump is to promote exports through a "weak dollar" policy. The latest research report from Deutsche Bank indicates that in order to offset the trade deficit, the dollar needs to depreciate by at least 40%.

However, achieving a depreciation of the dollar is not as simple as imagined.

Currently, the potential policies of the Republican Party may actually lead to a "strong dollar", including increasing consumption taxes, providing funds for business tax cuts, etc. This would increase the savings rate and corporate profits in the U.S., thereby reducing the current account deficit and supporting a stronger dollar.

Deutsche Bank has proposed three possible ways to achieve a "weak dollar", but upon analysis, the feasibility of these approaches is not high.

Path One: Foreign Exchange Market Intervention

Deutsche Bank believes that a significant depreciation of the dollar is needed to offset the trade deficit. According to calculations, the dollar needs to depreciate by at least 40%.

Since many imported goods are priced in dollars, the price elasticity of U.S. imports is low, meaning that the demand for imports is less responsive to price changes. Therefore, a larger foreign exchange adjustment is needed to be effective, which poses higher requirements for funds.

Firstly, unilateral foreign exchange intervention would require trillions of dollars, which is not realistic. Deutsche Bank's analysis shows that if a foreign exchange reserve fund equivalent to 10% of GDP or $2 trillion is established, additional government bonds would need to be issued. This not only faces debt ceiling restrictions but also increases the financial burden on the federal government. Taking the 2% negative interest rate differential between U.S. and German bonds as an example, there would be an additional interest expense of $40 billion per year. Trump's purchase of foreign assets at the expense of taxpayers is politically unacceptable.

Moreover, the amount needed to weaken the dollar may far exceed $2 trillion. For example, the Japanese Ministry of Finance spent about $63 billion in bond market intervention over two days. If a similar effect is desired in dollar trading, the U.S. Treasury would need to spend about $250 billion in two days and $1 trillion in two weeks. Even for the U.S. federal government, this cost is too high.

Furthermore, multilateral intervention also has limitations. This is because market intervention goes against the Group of Seven's commitment to market-determined exchange rates. In addition, intervention requires credible foreign exchange reserves, but the size of foreign exchange reserves of major developed economies is not large. Apart from Japan, G10 central banks would deplete all reserves within about ten days after intervention.

Of course, the current context does not support G7 joint exchange rate intervention. The success of past G7 currency agreements was driven by consensus, but in the current environment where tariffs are used as negotiation tools, the situation would be completely different as it would push currency fundamentals in the opposite direction. The shift in monetary policy is beyond the mandate of G10 central banks. As ECB President Lagarde stated, "Tariffs are more likely to push the ECB towards dovishness and lead to a depreciation of the euro."

Path Two: Encouraging U.S. Capital Outflows

Deutsche Bank believes that encouraging U.S. capital outflows is a feasible policy to induce dollar depreciation. "This would be a more successful approach." It may be more effective to encourage the flow of private sector funds than to try to counteract public sector fund flows. However, the research report pointed out that historically, few countries have adopted this approach, with Switzerland in the 1970s being an exception. At that time, the United States suspended the convertibility of the US dollar into gold, leading to safe-haven funds flowing into Switzerland and causing the Swiss franc to appreciate. To address this situation, Switzerland imposed a 2% penalty on foreign deposits every quarter, eventually reaching 41% annually, to encourage capital outflows. However, the franc actually strengthened during this period.

Similar measures include taxing interest on US Treasury bonds, or setting residency requirements or quotas for the acquisition of financial assets. While it is possible to implement policies targeting individuals or assets sensitive to national security in certain countries, Deutsche Bank believes that widespread introduction of capital controls is inconsistent with the Trump administration's policy of maintaining the US dollar as the world's reserve currency. Trump explicitly stated this in an interview with Business Week, and the Republican National Committee also listed it as a policy priority.

Path Three: Weakening the Independence of the Federal Reserve

Deutsche Bank believes that weakening the independence of the Federal Reserve may be the most effective way to weaken the US dollar. Although this is not an explicit policy of the Trump campaign, there are rumors that some of Trump's allies plan to weaken the independence of the Federal Reserve, posing a risk to the strong dollar. The 2022 UK crisis showed that if the central bank's independence is weakened, the market may anticipate increased inflation risks and a decrease in the purchasing power of the currency. Therefore, higher returns are required to compensate for this risk, leading to an increase in the nominal yield of long-term bonds.

However, Deutsche Bank points out that the likelihood of this scenario is low. Firstly, the US president can only appoint 7 out of the 12 voting members of the Federal Reserve, and these appointments are made in stages. There are only two vacancies in the next four years: Powell (term until 2028) and Cogley (term until 2026). In addition, there is uncertainty about whether the president can dismiss members of the Federal Reserve Board, and even if Powell is removed from the chairmanship, he can still remain on the board as a director and may be selected by the Federal Reserve as the chairman of the policy committee.

It is worth noting that Trump explicitly denied this week any plans to weaken the independence of the Federal Reserve and expressed support for Powell to continue as chairman