A flight from the dollar could wreck America’s finances – The Economist – 13.04.25
- Michael Julien
- 4 days ago
- 4 min read
The currency’s dominance enables very high debts and deficits, meaning a plunge might spell disaster.
In 1990s Japan the worst days of a market crisis brought about a “triple yasu” loss: a fall in stock markets, a rise in bond yields and a declining currency. It is now America that must stomach this noxious combination. Although President Donald Trump’s tariff pause provided a brief respite, the triple yasu has made an unwelcome return. Most alarming lately have been movements in the bond and currency markets. In total since April 1st the dollar has fallen by more than 4% against a basket of major currencies, at the same time as yields on ten-year Treasury bonds have risen by 0.3 percentage points (see chart).
In Japan the triple yasu was associated with national decline. Yet a flight from all American assets represents a far greater loss. That is because the dollar and Treasury bonds are the world’s havens, and the global financial system has been built on the assumption that they are safe.
If bond yields were rising because of stronger American economic growth, they would bring about a stronger greenback. That the dollar is falling instead suggests investors are worried about America’s economic stability. It is an ominous repeat of a pattern that struck in Britain after Liz Truss’s disastrous “mini-budget” in 2022, which promised unaffordable tax cuts. Although Mr Trump’s tariffs raise money for the government, such revenue could be dwarfed by the higher pay-outs required by rising bond yields.
Moreover, America’s budget is already in an awful state. Global demand for the dollar and Treasuries has enabled America to run a more extravagant budget than that which sparked the crisis in Britain. This special status is known as “exorbitant privilege”. The federal government’s net debts are worth about 100% of GDP. In the past 12 months, America has disbursed 7% of GDP more than it raised in revenue, and spent more on interest payments than on national defence. Over the next year officials must roll over debt worth nearly $9trn (30% of GDP).
Now that privilege is under threat. Mr Trump’s tariffs are likely to cause deeper economic harm in America than elsewhere. They also reveal American policymaking to be arbitrary and capricious. Who can predict where tariffs will be in a week’s time? The sense of unease goes beyond economics. Mr Trump’s willingness to defund universities that house his critics, to withdraw government business from law firms which work with his legal opponents and to deport migrants to a prison in El Salvador without a hearing appears to threaten the norms on which American society has been built.
It is, therefore, no longer so hard to imagine dire scenarios: the president trying to fiddle with economic data, say, or removing the independence of the Federal Reserve. Indeed, a case is making its way through the courts that could make it easier for Mr Trump to do the latter. It is a particularly bad time for a cloud to sit over the institution responsible for fighting inflation. The economy has been through several years of soaring prices, and faces another surge owing to tariffs. On April 11th John Williams, president of the New York Fed, said that he expected inflation of 3.5-4% this year; a University of Michigan survey revealed that consumers expect prices to rise by 6.7% over the next year, the highest rate since 1981.
No wonder investors are spooked. Yet Republicans are seeking to extend and add to tax cuts from Mr Trump’s first term, as if America’s creditworthiness were unquestionable.
On April 10th the House of Representatives approved the Senate’s blueprint for a budget that could add $5.8trn in deficits over the next ten years, according to the Committee for a Responsible Federal Budget (CRFB), a think-tank. That is more, in cash terms, than Mr Trump’s first-term tax cuts, the response to the covid-19 pandemic in 2020 and President Joe Biden’s stimulus and infrastructure bills combined. To get around procedural limits on deficits, Republican senators plan to score their budget bill against a “current policy” baseline—ie, to pretend that Mr Trump’s earlier tax cuts are already permanent. The result will make forecasts of America’s debt to GDP, already grim, truly woeful. The CFRB warns that the pace at which the ratio is increasing could double.
Market moves could force further course corrections, by Mr Trump or by Congress. On April 11th the administration exempted smartphones and other consumer electronics from supplementary levies on China. But profound damage may already have been done. In recent years, economists have warned that exorbitant privilege, by making borrowing cheap, might induce America to take on too much debt, thereby making the dollar financial system fragile and vulnerable to a run. On this theory, it could collapse, much as the dollar’s peg to gold did in 1971, when the Bretton Woods system of fixed exchange rates imploded. Little more than a week ago King Dollar’s reign looked secure and such a calamity seemed highly remote. It is a measure of Mr Trump’s havoc that it now appears possible. ■
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