Does Trump Threaten the US’ “Exorbitant Privilege”?
David Yang | 29 April 2025
Summary
United States (US) President Donald Trump’s trade and economic policy undermines the USD’s status as the world’s reserve currency, and US government bonds as the global safe-haven asset.
Trump’s expressed goal of getting rid of the US’ “exorbitant privilege” would raise US borrowing costs and require domestic investment to make up for the loss of foreign capital. Trump’s volatile trade policy raises uncertainty.
Deteriorating trust in policy making will likely induce a gradual global de-risking from the USD and US assets, and drag down GDP growth.
Global unease over US economic policy is causing a crisis of confidence in the US dollar, with financial markets experiencing volatility not seen since COVID and the 2008 Financial Crisis. President Trump’s 2 April announcement of reciprocal tariffs shocked markets with their severity and scale. Duties ranging from 20% on the European Union to 145% on China triggered fears of a global recession, while his attacks on the Federal Reserve’s independence shook confidence in the stability of monetary policy. The ensuing market sell-off caused the S&P 500 to plummet 12.1% in the week after the announcement.
Trump’s policy disrupted US financial markets. Historically during downturns, investors tend to sell riskier stocks and buy US government bonds as globally recognised safe-haven assets in USD. This increased demand pushes up their price, which decreases their yields as a fixed-income asset. As in the 2008 Financial Crisis and the 2020 COVID pandemic, when stock markets fall, bond yields go down and the dollar rises. However, in the recent market panic bond yields rose while the dollar fell, indicating that investors are not buying up Treasuries, but selling them.
The status of the USD and US Treasuries as a global safe-haven asset has rested on confidence in the US economy’s strength and stability, as well as the government’s ability to meet its debt obligations consistently. However, Trump’s policies are causing investors to reassess these assumptions, as his administration is critical of the USD’s reserve status. To them, global demand for dollars artificially increases their value, hurting US exporters as their goods become more expensive in foreign currencies. Trump’s calls for Federal Reserve (Fed) Chair Jay Powell’s removal over not cutting interest rates soon enough challenge the Fed’s independence and have shaken investor confidence in the US. Investors have speculated that Trump might use tariffs and possibly refuse to pay interest on its debt as a negotiating tactic to ultimately strike a deal with major economies to depreciate the USD, a so-called “Mar-A-Lago Accord.”
A sudden loss of confidence in the dollar would severely disrupt global financial markets, but hurt the US the most. Global investors would flock to other safe assets - German bonds, Euros and gold have risen as alternatives - but with almost 90% of foreign exchange transactions using USD, markets would be plagued by currency risk. The US, however, faces even greater challenges. If foreign investors owning 31% of US debt sold off their bonds, US government borrowing costs would soar. The US runs a huge government deficit, 6.28% of GDP in 2024, that it can only sustain due to constant global demand for its bonds pushing down yields, known as its “exorbitant privilege”. Annual US interest payments on its debt have more than doubled since 2020 to 11.9% of Federal spending in 2024; a large rise in yields would threaten the sustainability of its debt, not helped by Trump’s desire for large tax cuts.
Compounding this issue is the effect on the US current account deficit. The current account, which is composed of the trade balance and net investment income (NII), represents the net flow of wealth into or out of the country. A devalued dollar would improve the trade balance as exports become more competitive and imports dearer. As yields rise, the interest paid out to foreign bondholders increases, though if the absolute number of foreign bondholders fell sharply in a sell-off then NII would likely increase. This achieves Trump’s goals of reducing the current account deficit, but at a great cost. Foreign investment in the US, which contributes to a current account deficit, makes up for a lack of domestically funded investment. Without this, the gap between investment and domestic savings would need to narrow. Savings could increase if US households buy up the sold-off US assets, reducing consumption, or if private investment needs to fall. Such policies would reduce GDP growth, potentially putting the economy into recession. The Fed will be unlikely to bail out the US economy with deep interest rate cuts, as Powell aims to preserve the Fed’s independence, preferring to maintain credibility in keeping inflation down in the face of tariff shocks.
A sudden crash is unlikely, as Trump has shown himself to be somewhat receptive to financial markets. Trump paused reciprocal tariffs above 10% except those on China for 90 days in response to market turmoil, and has exempted electronics like smartphones and laptops from all duties. Recent auctions for long-maturity Treasury bonds have retained stable demand. Nuclear options like taxing capital inflows or defaulting on debt payments have been floated as ideas by Trump and those close to him, but such actions are unlikely as they would cause immediate mass capital flight and guarantee a deep financial crisis. The main issue is the growing uncertainty and lack of trust in US policymaking. With no confidence in tariff threats or temporary reprieves, combined with constant attacks on US monetary independence, it is more likely that the world will realise it cannot rely on US markets.
Forecast
Short-term (Now - 3 months)
Market volatility will likely remain elevated as investors latch onto any signal of policy intent from the Trump administration. Surprises are likely over the outcome of reciprocal tariff negotiations before the 90-day pause ends on 9 May 2025.
Medium-term (3-12 months)
Barring extreme policies like taxing capital inflows or defaulting, Treasury yields will likely settle at a slightly elevated rate, reflecting an increased risk premium but slightly lower expected interest rates.
Long-term (>1 year)
Continued policy uncertainty will accelerate the global gradual reduction in USD reserves. The effects of tariffs will be negative on US GDP growth.
Powell is unlikely to be removed before his term as Fed Chair ends in May 2026. Fear over the independence of his replacement will likely send Treasury yields up as the date nears.
