US President Donald Trump’s attacks on Federal Reserve Chairman Jerome Powell are another sign of a new era in economic policymaking and governance.
After repeatedly calling Powell “stupid” for not lowering interest rates quickly enough, Trump has now directed government prosecutors to launch a criminal investigation into Powell for allegedly misleading the Senate about the costs of renovations to central bank buildings, allegations Powell denies.
Although the immediate risk of forcing a rate cut too quickly would be higher US inflation, Trump’s unprecedented attacks on Powell cannot be seen solely as a domestic issue.
This is due not only to the US economy being the largest in the world, but also to how businesses, consumers and governments use the US dollar in their economic operations.
Since the 1980s, when Trump was a famous businessman, he has made his vision for the economy clear. Now, as the most powerful man in the world, he attempts to put that vision into practice.
In this vision, there are clear winners and losers in any economic transaction, and instead of mutual benefits, the US must always be the winner.
Although fairness in trade relations is always open to academic and political scrutiny, the post-World War II global economic order has resolved disputes through bodies such as the World Trade Organization.
A rules-based international trade regime helped generate spectacular economic growth in the second half of the 20th century. However, the beginning of the 21st century was not favorable for the world economy, with two major financial crises in the early 2000s (the dotcom bubble and the global financial crisis).
Added to this is the rise of populist and authoritarian politics and the Covid pandemic, which changed the terrain on which the rules-based global economy had prospered since the 1950s. Threats to that global economic order also threaten the dollar’s preeminent place within it.
The US dollar was the official reserve currency of the world economy between 1944 and 1976 through international agreements backed by gold reserves. International trade imbalances, which initially favored the US but later benefited the rapidly recovering European and Asian economies, put an end to this gold standard.
However, due to what some scholars call path dependency (where society tends to maintain familiar processes), the dollar has continued to act as the world’s reserve currency.
Advances in financial theory and practice, such as new valuation models and greater computing power, have also helped companies and governments manage their affairs in this deregulated but highly integrated economic environment.
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The question of the autonomy of the Federal Reserve
Another important factor in the dominance of the dollar has been the strength of institutions, including the supremacy of law in the United States. A key example is the Federal Reserve and its autonomy over monetary policy to ensure maximum employment and price stability in the US economy.
This autonomy is enshrined in the US Constitution, and many developed and developing countries followed suit, granting political autonomy to their central banks, often after crises caused or aggravated by politicians. Since the 1980s, the Fed was the most important source of economic information for businesses, investors and governments around the world.
But now Trump is threatening to roll back this autonomy and replace it with his own economic vision, which involves lower interest rates to boost economic activity and decrease government debt payments.
Trump is likely to follow the lead of Turkish President Recep Tayyip Erdoğan, who put his country’s economy into negative rate territory in 2019, which then led to high annual inflation, estimated by some to be in the triple digits.
Any politically motivated rate cut in the US, driven by a new Fed chair (Powell’s term ends in May), will almost certainly generate inflationary pressures, as it will stimulate citizens’ borrowing and consumption, especially if they perceive the value of their dollars deteriorating against goods, services and other currencies.
This can become a vicious cycle, where inflation spirals out of control and American consumers avoid holding dollars, seeking alternatives such as gold or cryptocurrencies until orthodox monetary policy is adopted again. Of course, Trump is now an advocate of cryptocurrencies, having in the past compared bitcoin to a “scam.”
None of this fits well with his election promise to reduce consumer prices.
Global confidence and interest in US assets is already declining, as many investors openly or anonymously (for fear of retaliation from the Trump administration) discuss their growing aversion to the US economy, which does not favor the dollar. A depreciated and politically controlled dollar would likely mark the beginning of the end of dollar hegemony.
Over the years, commentators wrongly announced the beginning of this decline following events such as the introduction of the euro and China’s moves to foster a new global monetary system, but these ignored how path dependence and inertia in economic affairs reduce uncertainty and can sustain a currency’s status as a global reserve.
However, if Trump and his successors realize their economic vision, the world could finally see a true retreat in the fortunes of the dollar, accompanied by greater economic regionalization determined by the “us versus them” mentality.
History teaches how similar episodes led to open conflicts and how the world managed to prevent them through a rules-based international order.
This article was originally published by The Conversation
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