Effect of Trump’s Tax Plan on the U.S. Dollar
U.S. stocks are near record levels and encouraging U.S. economic data continues to roll in, supporting the notion that the U.S. economy is heading in the right direction under newly elected President Donald Trump’s economic policies and tax plan. But many believe President Trump’s tax policies could lead to a U.S. dollar collapse in 2017.
That’s a tough pill to swallow from today’s lofty heights. The U.S. dollar has great momentum and the U.S. dollar index is at its highest levels since 2003. Investor optimism is buoyed by Donald Trump’s proposed tax cuts, deregulation, protectionism, and the belief his tax plan will stimulate investment, job creation, and “Make America Great Again.” Under President Obama, gross domestic product (GDP) averaged just 2.3%; in his last year of office, it was an anemic 1.6%.
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But interestingly, it’s these same proposed tax cuts that could actually lead to a collapse in the U.S. dollar in 2017. Admittedly, the collapse of the U.S. dollar is a crisis that has been in the making for decades and the blame for the collapse cannot be laid solely at the feet of President Trump. In fact, the collapse of the U.S. dollar is the final member of the economic Unholy Trinity: the Financial Crisis, the Great Recession, and the Great Greenback Crisis of 2017.
The first two stages of the Unholy Trinity have put the U.S. on the path to imaginary prosperity. Thanks to years of quantitative easing and artificially low interest rates, U.S. equities have been soaring along with the U.S. dollar.
Over the last four years, the U.S. dollar has enjoyed annual gains (in real terms) of approximately 10%. Since 2013, the S&P 500 has advanced 66%. In light of weak economic conditions, this excessive growth has left both the U.S. dollar and stocks poised for a crash in 2017.
The underlying fundamental story is bullish for the U.S. economy and the U.S. dollar. But the problem is, the Trump administration doesn’t want a strong dollar. During the first presidential debate, Trump said the bull market was “in a big fat ugly bubble.” He has also said, on numerous occasions, that the U.S. dollar is too strong; suggesting the U.S. would turn its back on a two-decade policy favoring a strong Greenback. (Source: “Trump: We Are in a Big Fat Ugly Bubble,” Bloomberg, September 26, 2016.)
A weak U.S. dollar is what Donald Trump needs if he wants to bring back manufacturing jobs to America. Manufacturing would benefit from a low U.S. dollar but some critics maintain that Trump’s economic policies actually support a higher U.S. dollar.
And that’s what we have right now; a strong currency. The U.S. dollar is still near a 14-year high and is expected to rally for much of the year. That just means the U.S. dollar has further to fall when it does collapse. According to one economist, the U.S. dollar will collapse just like it did in the early 1980s. (Source: “We’re going to have a dollar collapse like the 1980s, strategist says,” CNBC, February 6, 2017.)
The Great Greenback Crisis of 2017
What needs to happen for the U.S. dollar to collapse? There needs to be underlying weakness and there needs to be a replacement for the world’s reserve currency. First, the U.S. dollar (despite its 27% increase since mid-2014) is fundamentally weak.
Between 2000 and 2008, the U.S. dollar fell more than 50% against the euro, which is the strongest economic region in the world. During that period, the U.S. debt soared from $5.67 trillion to $10.02 trillion. Since then, the U.S. dollar has risen 50% against the euro and U.S. debt has hit $19.95 trillion.
Moreover, the U.S. has a debt-to-GDP ratio of 106%. What’s the best way to repay that debt? With cheaper money. That’s assuming the U.S. can control the collapse of the U.S. dollar.
And assuming Trump even wants to repay that debt. He has, after all, called himself “the king of debt.” It’s going to be tough to tackle U.S. debt when you’re cutting taxes and increasing spending. The national debt nearly doubled under President Obama, from roughly $10.0 trillion to roughly $20.0 trillion. Will the same thing under happen President Trump?
And does he really care? As you’ll recall, he said in the run-up to the election that the best way to repay America’s debt is to buy it back at a discount.
“Now of course I was swashbuckling, and it did well for me, and it was good for me and all of that. And you know debt was always sort of interesting to me. Now we’re in a different situation with a country, but I would borrow knowing that if the economy crashed you could make a deal. And if the economy was good it was good so therefore you can’t lose. It’s like you make a deal before you go into a poker game. And your odds are much better.” [Emphasis added.] (Source: “Trump Floats U.S. Debt Renegotiations If Economy Sours,” Bloomberg, May 5, 2016.)
Some have interpreted this as an offer to buy back U.S. debt at 85 cents on the dollar. Defaulting on our debt would tank the U.S. economy and send investors on the hunt for a new reserve currency.
The Greenback has been the world’s reserve currency since World War II and is used for more than 40% of all global transactions. That means the U.S. can deal directly with any country it wants using its own currency. And can even print more if need be.
This is not an option for any other country. If Germany wants to buy oil from Saudi Arabia, it uses U.S. dollars. But, Germany can only acquire U.S. currency if it sells something to someone else or buys it. As a result, central banks from around the world hold the Greenback in their reserves to pay for transactions.
With the U.S. drowning in debt and the economy still shaky, central banks are increasingly wary of using a devalued U.S. dollar as their reserve currency. China is already calling for a global currency to replace the U.S. dollar. Naturally, the U.S. and Europe are not keen on the idea.
Obviously, the U.S. dollar is not going to lose its reserve currency status in 2017, but it’s important to show that if central banks and corporations turn their back on the Greenback, the U.S. will no longer be able to negotiate or buy its way out of debt.
What Are the Economic Consequences of a Weak U.S. Dollar?
Will the U.S. dollar collapse in 2017? An unassuming pull-back in economic indicators would not trigger a loss of confidence in the U.S. dollar. For that to happen, there would have to be something more cataclysmic.
Today, foreign holders own $6.2 trillion in U.S. debt. For the time being, most governments trust the U.S. economy is solid and that U.S. debt is a safe investment. Should that faith in U.S. debt be challenged though, it would have devastating consequences for the U.S economy.
If Japan, the largest holder at $1.09 trillion, or China, with $1.05 trillion, start to dump their U.S. dollars, it would cause panic. Interest rates on U.S. debt would soar, which would mean higher borrowing costs for the U.S. government. This would make it extremely difficult for President Trump to implement his tax cuts and increase spending. And make it virtually impossible to achieve his goal of annual GDP growth of four percent.
Credit markets would dry up and banks would be less likely to lend money, which would be the death knell to the U.S. economy and the U.S. dollar.
| Country | U.S. Debt Held December 2016 |
| Japan | $1.09 Trillion |
| China | $1.05 Trillion |
| Ireland | $288.2 Billion |
| Cayman Islands | $263.5 Billion |
| Brazil | $259.2 Billion |
| Switzerland | $229.3 Billion |
| Luxembourg | $223.4 Billion |
| U.K. | $217.1 Billion |
| Hong Kong | $191.4 Billion |
| Taiwan | $189.3 Billion |
(Source: “Major Foreign Holders Of Treasury Securities,” U.S. Department of the Treasury, last accessed March 10, 2017.)
A premature rate hike by the Fed could also trigger an economic collapse and send the U.S. dollar spiraling. The Fed raised rates in December 2015, for the first time in a decade, because it thought the U.S. economy could support the rate hike. It couldn’t. Stocks plunged in the early part of the year before rebounding, for no real reason.
Two or three rate hikes in 2017 could trigger consequences few could expect. American households are in debt, wage growth is still anemic, and most Americans have no savings. A rate hike in this environment does not bode well for a country that relies on consumer spending to keep it going. When the strong U.S. dollar confronts weak economic growth later in 2017, the Greenback could be collateral damage.
Moreover, Trump’s pro-growth, protectionist policies could also undermine U.S. economic growth all on its own. As Trump said, his job is to represent the interest of the U.S., not the rest of the world. What does that look like when it comes to trade? It looks like it’s going to get a lot more expensive for other countries to do business with the U.S.
Trump said he would consider a 20% to 45% tariff on imports from China and Mexico and a five percent tariff on all goods imported into the U.S from everywhere else. Unfortunately, when it comes to trade wars, no one ever wins. If the U.S. does impose trade tariffs on China or Mexico, you can bet they will retaliate. In addition to their own tariffs, China could reduce its $1.05 trillion of U.S. debt holdings. (Source: “Trump is reportedly considering a 5% tariff on all imports,” Business Insider, December 22, 2016.)
This would have an immediate impact on U.S. consumers, the broader economy, and Wall Street. A depressed Greenback, reduced trade, and tariffs would put an end to cheap products and services. But again, Americans can’t afford to pay more than they already do. They’re making less, saving less, and with rising rates and inflation, paying more. Not surprisingly, 44.2 million Americans, more than 7.5% of the population, rely on food stamps to get by. To put that into perspective, we’re eight years into the so-called recovery, but we’re at the same levels we were in 2011. In 2007, before the Financial Crisis, 26.3 million American received food stamps. (Source: “Supplemental Nutrition Assistance Program Participation and Costs,” United States Department of Agriculture, March 10, 2017.)
Trade wars could also force other countries, who now see the U.S. as an unreliable trade partner, to create their own trade agreements. This could send the U.S. economy into a tailspin and prop up other currencies like the yuan or euro.
Protecting Yourself Against a Collapse in the U.S. Dollar
A collapse in the U.S. dollar is not as unlikely a scenario as many would want you to believe. Investors, consumers, and Wall Street are all euphoric about President Trump and what his economic policies could do for the U.S. economy. On the domestic side, there is a lot that could derail his efforts. Donald Trump’s foreign policy and protectionist views are a whole other matter.
The fact is, the U.S. dollar is just a piece of paper that only has value because it’s backed by the encouraging words of the U.S. government. If the world loses faith in the U.S. economy and its ability to service its debt, the U.S. dollar would truly have no value. It would also lose its reserve currency status.
When it comes to hedging against economic uncertainty and a potential collapse in the U.S. dollar, the best place for investors to look is precious metals like gold, silver, and platinum. The days of the Greenback being linked to the price of gold are long gone. But should a currency like the U.S. dollar collapse, would you rather hold it, or the (one-time) face value equivalent in gold, silver, or platinum?
