Shaken Dollar and Doubts Over US Treasuries: Three Key Causes [Economic Policy Zoom-In]

Erratic Tariffs Spark Economic Uncertainty
Fed Halts Rate Cuts Amid Inflation Concerns
Debt Level and Growth Accelerate Rapidly
Yet Government Expands Spending and Pursues Tax Cuts
Trump's Attempts to Shake Up the Fed, Including Talk of Removing Powell
Backfire by Fueling Sell-Off of US Assets

"Because there is no currency that can fully replace the US dollar, the dollar will continue to hold the top spot in global finance. However, its dominance will not be as unrivaled as before. The dollar entered a gradual decline phase after peaking in 2015. This trend could accelerate due to the policies of the Trump administration. In particular, there are significant concerns about the US fiscal deficit and rising interest rates."

Kenneth Rogoff, a professor at Harvard University, made these remarks in recent interviews with various media outlets following the publication of his new book, "Our Dollar, Your Problem."

The title of the book, "Our Dollar, Your Problem," refers to a statement made by John Connally, the US Treasury Secretary in 1971 when the US suspended the gold convertibility of the dollar. When officials from other countries asked, "If the dollar is no longer convertible to gold, doesn't that mean the US can print as many dollars as it wants?" Connally replied, "It's our dollar, but your problem." Professor Rogoff described this as a remark symbolizing American arrogance.

In the early chapters of his new book, Professor Rogoff explores the question, "Could the ruble have become the world's reserve currency?" While this may sound absurd today, it was not so in the 1960s and 1970s. At that time, the global economy was divided into two economic blocs: the liberal democratic bloc centered on the United States and the socialist bloc led by the Soviet Union. The ruble bloc's economy was growing rapidly, and many economists believed the Soviet Union would reach economic parity with the United States. Ultimately, this did not become reality.

The core argument of the book is that "the dominance of the dollar is never guaranteed and could very well collapse." Professor Rogoff noted that rapidly increasing US government debt and political interference with the Federal Reserve (Fed) could cause investors to lose confidence in the dollar, potentially leading to a sudden, rather than gradual, collapse of the dollar's status. While such a scenario may sound far-fetched, the collapse of the Soviet Union once seemed just as unlikely.

Amid recent events such as Moody's downgrade of the US credit rating, the decline in the dollar's value, and rising US Treasury yields, Professor Rogoff's comments are drawing attention. We analyzed three main causes behind the recent developments.

Issue 1. Unreliable Trump Policies

US Treasury prices are on a downward trend (with yields rising). On May 19, the first trading day after Moody's downgrade of the US credit rating, the yield on 30-year Treasuries briefly surpassed the psychological threshold of 5%, reaching 5.01%. This is a significant increase from 4.786% at the end of last year. The benchmark 10-year yield also climbed to 4.52% during the session, higher than the 4.2% level at the end of April this year. The dollar index (DXY), which measures the dollar's value against six major currencies, recorded 99.68 on May 27. Compared to January 20, the day of President Trump's inauguration (109.35), this is a decline of about 9%. The combination of rising yields and a falling currency value is a warning sign. Investors leaving despite higher yields suggests that the US is now seen as a risky country for investment.

Until now, investors have trusted the stability of US assets and made them the backbone of global finance. The depth of the $27 trillion US Treasury market has made Treasuries a safe asset, and the dollar remains the dominant currency in nearly all transactions involving goods, commodities, and derivatives. This has led to the perception of "American exceptionalism," the idea that the US is uniquely trustworthy compared to other countries.

However, policies introduced by the Trump administration in its second term have undermined this long-standing trust. The tariffs announced in early April lacked clear justification for how they were calculated, and within just a few days, the US and China raised each other's tariff rates by more than 100%, only to suddenly lower them to 30% and 10%. Recently, the US threatened to impose a 50% tariff on the European Union starting June 1, but then postponed it to July 9 just two days later. The excessive confusion shows a complete lack of seriousness in policymaking. Trump has also slashed research and development budgets, targeting academic research institutions such as universities?the source of innovation?and made it harder for talented foreign professionals to obtain visas.

Trump's reckless tariff wars have created uncertainty throughout the economy. The US growth rate, which was 2.8% last year, reversed to -0.3% (annualized) in the first quarter of this year. The situation now calls for concerns about a recession. Sharp tariff increases are disrupting supply chains and fueling inflation, which will cause pain for consumers.

Due to inflation concerns stemming from tariffs, the Fed has halted interest rate cuts. The Fed lowered the benchmark rate three times in the second half of last year, from 5.25-5.50% to 4.25-4.50%, a reduction of 1 percentage point. However, this year, because of uncertainty caused by Trump, the Fed has kept rates unchanged for three consecutive meetings.

Issue 2. Excessive Fiscal Deficit and National Debt

Moody's, the only one of the world's three major credit rating agencies that had maintained a top (AAA) rating for the US, downgraded the US sovereign credit rating by one notch from 'Aaa' to 'Aa1' after the market closed on May 16. This is because there are no signs of national debt decreasing amid ballooning fiscal deficits, continued government spending increases, and tax cut policies.

The current US fiscal deficit is about $2 trillion annually (about 2,801 trillion won), exceeding 6% of GDP. Generally, it is considered desirable to keep the fiscal deficit within 3% of GDP. Moody's projects this ratio will expand to nearly 9% by 2035. In 2018, total US debt stood at about $21.5 trillion, but it has now surpassed $36 trillion. Both the scale and the rate of increase in debt are markedly different from before.

Inflation concerns are tying the Fed's hands, while high interest rates are causing the debt to snowball. A 1 percentage point difference in interest rates results in about $360 billion in additional annual interest costs. The amount paid by the US government in interest on Treasuries increased from $414 billion in 2010 to $1.13 trillion (about 1,580 trillion won) last year. About one-seventh of the US budget is now spent on interest payments, which is more than defense spending.

Furthermore, concerns about US fiscal deterioration are growing after a tax cut bill, which includes hundreds of billions of dollars in tax reductions, passed the House Budget Committee in April. On May 22, the bill passed the House with 215 votes in favor and 214 against and moved to the Senate. According to the Committee for a Responsible Federal Budget, if enacted, the bill could increase national debt by up to $5.2 trillion over the next ten years. This would raise the fiscal deficit-to-GDP ratio by an additional 2 percentage points each year.

Issue 3. Doubts About Central Bank Independence

Trump is demanding that the Fed cut interest rates. After the announcement on May 13 that the April consumer price inflation rate had slowed to 2.3% year-on-year, Trump posted on his social network service (SNS), "There is no inflation, and prices for gasoline, energy, and almost all food items have fallen. The Fed should cut rates like Europe and China."

After the tariff announcement in early April, when investors dumped US assets and markets became volatile, Trump pressured the Fed to cut rates and even raised the possibility of removing Chairman Powell. Trump's attempts to "shake" the Fed have only further fueled the sell-off of US assets. While the Fed is an independent institution and cannot remove its chair without just cause, Trump's ability to appoint a new chair aligned with his preferences when Powell's term expires in May next year remains a possibility.