Trump wants a ‘weak’ dollar. Is that good news for India?

For long, US President Donald Trump wanted the dollar to “weaken” and support the American industry. So, when the dollar index (DXY) fell 10.5% since January, accentuated by Trump’s tariffs in April, everyone thought it would make the man happy.But the fact is, a falling dollar could cause further weakness in the US market as funds flow out of the country. Does Trump really want a weak dollar? Well, it is not as simple as it appears. Trump does not exactly want a weak dollar. He wants other currencies to get stronger against the dollar. Or in other words, he doesn’t want other currencies to be unfairly priced. Some consider this to be a euphemism for a weaker dollar. But while the US wants to have a weaker dollar, it also wants other countries to invest in the US market in the form of treasury or private equity.So, how can Trump manage to reduce the trade imbalance without creating any issue with the capital account?In times of turmoil like today, the dollar should be bid higher. But it slumped, along with the recent crash in the US bond market. The fall came due to the unwinding of the US exceptionalism trade and aggressive selling by foreign investors with recession bets going up. This is certainly not what was wished for. The medicine for correcting trade imbalances is starting to have side effects.When the equity markets fell following the announcement of Trump’s tariffs, there was a belief that money would move into the bond markets and yields would come down. But that did not happen. There was a sell-off in the bond markets. The bond markets are considered to be a safe haven, but Trump’s tariffs created distrust in US markets, which experienced a capital outflow. Something that happens in emerging markets. Now the Trump administration has put a 90-day pause on tariffs, which has boosted capital markets.The trade deficit for the US is associated with the fact that the dollar is the reserve currency of the world and exporting countries do hold dollars in the form of US debt. For example, Japan accounts for $1.07tn, China $761bn and the UK $409bn. These countries are denominating international trade with other countries in dollar terms. Most currencies derive their value on the basis of interest rate differences and trade imbalances. So, the dollar has an extra layer of demand that is created by exporting countries. Now the US believes that this is benefiting some countries in an unfair way, especially China, which happens to be the main manufacturer of American goods. medium120335384“The trade deficit is the mechanism for how the dollar gets out into the world to serve as the global reserve currency. If the whole world needs dollars and you want to quickly stop this flow of dollars out into the world, then the system is going to seize up and it is going to have consequences. If you are successful in reducing the trade deficit and there are fewer dollars going out in the world, then there has to be weaker demand for the dollar eventually,” said Lyn Alden, an investment strategist, during The Monetary Matters podcast with Jack Farley.Alden focuses on fundamental investing with an emphasis on equities, currencies and digital assets. These days, she finds safety in gold, compared to US treasuries.That is true with many other global investors who are now finding comfort in the safety of precious metals, Swiss franc and Japanese yen. It is a worrying signal when investors take safety in gold. This has effects on the dollar, and it is developing cracks in the safe-haven status of the dollar. Could it also hurt its status as the global reserve currency?Trump has been cagey about other countries. He has frowned upon and threatened against the launch of a possible BRICS currency. China in the BRICS grouping is anyway now in a long-term trade war with the US.This has made foreign investors, who were pouring funds into the US, nervous. Foreign investments were one key reason driving the US outperformance over the years. Despite the recent correction, the S&P 500 is still valued at a price to book value of 4.93x, compared with the long-term average of 3.73x. But this is set to change, as the dollar weakness becomes structural.Fading US exceptionalismAt the end of 2024, foreigners’ net international investment position in the US was at $26.23tn. This amount is simply the excess of what foreigners invested in the US, compared to America’s investments in the rest of the world. This investment went up over 8x from $3tn 15 years ago. As the graphic below shows, much of the US exceptionalism was powered by foreign capital. medium120335411The issue now is how deep foreign investment unwinding can be. If foreigners accelerate divesting their US holdings, the dollar could continue to weaken while at the same time losing some of its appeal as a safe-haven currency.The recent crash in the US bond market was mainly due to investors unwinding their leveraged positions in the treasury market. But there are also expectations that long-duration bond prices will fall in future, causing losses to bondholders. Foreign financing of US debt could taper down.So, what does it mean for India?“A weaker dollar will definitely lead investors to look outside the US and this will be a big opportunity for countries like India. But we need to see if the US does anything to encourage investment in the country following these protective tariffs. The net effect may be hard to conjecture right now. But to begin with, there would be a flow of FPI funds to emerging markets, including India,” says Madan Sabnavis, chief economist at Bank of Baroda.From the Indian perspective, it will be important to see how competing currencies perform. A fall in the dollar will generally mean strengthening of other currencies under ceteris paribus conditions, which work against export-competitive advantage. Hence, it will be important to weigh how competing currencies fare on a comparative scale.“We must also see how exports fare as the tariff concerns will affect exports across the word and those which are more dependent on exports will face sharper trade deficits which can further weaken currencies. Here, India can be at a disadvantage as exports are less important and while the deficit can widen the rupee may not weaken as significantly as say those of other East Asian countries,” Sabnavis says.Rising debt and inflationA key intention of Trump’s tariffs is to raise resources and rein in the ever-expanding federal deficit. But tariffs are expected to raise inflation, while slowing growth will create challenges for the bond market. And the possibility of higher inflation will ruin the chances of rate cuts by the US Federal Reserve. Several experts are now projecting US bond yields to rise going forward after the initial dip that has already happened. With the US expected to issue $2.2tn worth of bonds this year, yields could inch in a scenario where inflation will be higher.According to a University of Michigan survey, closely tracked in the financial markets, released on April 11, respondents’ expectations for inflation in the US a year from now jumped to 6.7%, up from 5% in March. This is the highest level of inflation expectation since November 1981. Yields on the benchmark 10-year US bond spiked to roughly 4.5% from just below 4% last week.There is speculation that China’s central bank, which holds $760bn in US treasury debt, could be unwinding some of its positions as an act of retaliation. Foreign investors roughly hold 30% of the total US debt. The challenging aspect is that US bond yields may rise even as the economy faces a slowdown and the dollar is falling.The final cutThe recent dollar decline is a symptom of the macro problems that the world’s largest economy faces.It’s possible that instead of improving America’s comparative advantage, a weak dollar could be leading to a cycle of long-term adjustment of foreigners selling US assets.