The US dollar is experiencing a period of sustained weakness, hitting a four-year low in late January and prompting concerns about its long-term status as the world’s reserve currency. While President Donald Trump has downplayed the decline, markets are signaling a more serious assessment of underlying vulnerabilities linked to shifting US policies and a perceived erosion of institutional credibility.
The dollar’s recent slide follows more than a decade of strength, fueled by post-pandemic growth and relatively high interest rates between and . However, saw a nearly 10% drop in the dollar index – its worst performance since – largely triggered by Trump’s ‘Liberation Day’ tariff announcements in the spring. This downward momentum has continued into , raising questions about whether the current weakness is cyclical or indicative of deeper, structural problems.
A key concern is the conflicting nature of the Trump administration’s policies. The imposition of tariffs and the use of trade and financial relationships as leverage appear to contradict a growth strategy centered on technological advancement and capital deepening, particularly in the area of artificial intelligence. Even if the tariffs ultimately prove modest and don’t inflict significant direct damage, the resulting uncertainty is enough to weigh on the dollar.
This policy uncertainty is creating a “political risk differential” that is impacting the dollar, a phenomenon commonly observed in emerging markets where currencies tend to weaken under populist governments. Empirical research demonstrates that fragile institutions, discretionary fiscal behavior, and political interference in central banking consistently erode financial stability, often leading to inflation, capital flight, and persistent currency depreciation, even under floating exchange rate regimes. The combination of aggressive tariff policies and increasing political pressure on the Federal Reserve is creating a macroeconomic environment previously associated with economies possessing weaker currencies.
The United States is not alone in experiencing currency weakness linked to populism. Japan’s recent attempts to defend the yen through central bank intervention have been unsuccessful, despite expectations of tacit US support. The failure of the Bank of Japan stems from its own embrace of populist economic policies. A country with a large public debt burden, like Japan and the US, finds that expansionary fiscal policy undermines the credibility of any currency intervention.
Trump’s tariffs follow a similar populist pattern. The administration appears to be betting that the AI boom will deliver a rapid increase in productivity and deflation before the next election cycle. However, even if this short-term gamble pays off, the damage to the dollar’s underlying fundamentals may already be done. The mere threat of tariffs – regardless of whether they are implemented – has injected uncertainty into financial markets, altered portfolio allocations, and created the expectation of potential future levies.
While actual tariffs can have a short-term appreciating effect on a currency, tariff threats tend to weaken it by increasing US-specific uncertainty and, the dollar’s risk premium. Compounding this issue, the Federal Reserve faces a challenge more common in emerging markets: the erosion of its institutional independence. Public pressure from Trump, including legal threats against Fed officials, demands for politically timed rate cuts, and efforts to curtail its regulatory scope, undermine its ability to act decisively.
When central banks are forced to make procyclical or politically expedient decisions, the result is often higher inflation and a weaker currency. The experience of Turkey between and serves as a cautionary tale, with repeated political interventions in monetary policy driving inflation from below 10% to over 80% and causing a sharp currency collapse. Argentina has followed a similar trajectory. Once monetary authorities lose their autonomy, restoring market confidence requires drastic measures and significant economic hardship.
The United States, however, is not Turkey or Argentina. It possesses deeper markets, a stronger institutional framework, and the privilege of issuing the world’s dominant reserve currency. These advantages are not guarantees of invincibility, however. Institutional erosion is a gradual process, and even subtle doubts about the Fed’s independence can increase risk premiums, alter exchange rate dynamics, and weaken the stabilizing role of US monetary policy globally.
Recent fluctuations in gold and silver prices reflect these concerns, with increases interpreted as a hedge against diminished Fed independence and geopolitical tensions. The subsequent decline following Trump’s nomination of Kevin Warsh as the next Fed chair demonstrated that markets are now considering US-specific political uncertainty in the same way they assess risks in countries without reserve currencies.
US companies should be on alert. Those that benefit from political access, regulatory favoritism, or temporary tax advantages may enjoy short-term gains, but the weakening of macroeconomic fundamentals will ultimately erode their profits – even in an AI-driven economy. Investor optimism about the transformative potential of AI is already giving way to greater uncertainty and, with it, increased expected volatility.
The international repercussions are equally significant. Many emerging markets remain reliant on dollar-denominated financing, making them vulnerable to changes in US financial conditions. A weaker dollar may provide temporary relief, but the US-specific tariffs and policy uncertainties discourage foreign direct investment and complicate development strategies in poorer countries.
While the Trump administration asserts that the US can depreciate the dollar without losing its reserve currency status – through punitive tariffs, currency market interventions, or a stricter coordination framework between the Treasury and the Fed – Japan’s experience with yield curve control and currency management offers a cautionary lesson. When monetary and fiscal authorities are at odds and simultaneously attempt to set targets for exchange rates and long-term yields, risk premiums tend to increase, not decrease.
Building credibility in economic policy takes decades, but it can be eroded quickly. The causal chain runs from the weakening of institutional independence to the deterioration of inflation control and, to the loss of credibility. The question is whether the United States will heed this lesson before the costs become too difficult to reverse or conceal, not just for the US, but for the global economy.
