Why Didn’t Tariffs Push up the U.S. Dollar?

Two months ago, Scott Bessent, Stephen Miran and conventional macroeconomic analysts all agreed on one point: an increase in tariffs should raise the value of the dollar.

Bessent said a 10 percent change in the tariffs would lead the dollar to appreciate by 4 percent.

CEA Chair Miran also expected a rise in the dollar. Some of the ideas in his (in)famous paper seem to have been intended to address the difficulties a strong dollar would generate for a policy that aimed to reduce the trade deficit.

Conventional economic analysts pointed to the “Lerner” symmetry condition, which argues that a tax on imports is effectively a tax on exports, even absent foreign retaliation. Less imports means that foreign countries have fewer dollars to spend on exports (this analysis holds with unbalanced trade and capital inflows if the tariffs have no impact on capital flows and thus demand for dollars from the financial account).

Wall Street—and the City—initially agreed with this analysis.

Going “long” the dollar (betting on appreciation) was a standard “Trump” trade immediately after Trump’s election. Investors bid up the dollar in anticipation of tax cuts that would make U.S. equities more attractive—or because they expected that the tariffs promised during the campaign would reduce the supply of dollars by bringing down the trade deficit.

But this Trump trade didn’t work. Tariffs surprised to the upside, yet the dollar has slumped. It is now down around 10 percent against the G10 currencies (less against most emerging economies). Some now believe that the dollar has hit a long-term turning point.

So, why didn’t tariffs push up the dollar? I can think of five theories:

1. The tariffs are a tax hike, and fiscal consolidation is bad for the dollar.

1. If the U.S. simply raised revenues through a consumption tax, no one would have expected the dollar to rally. The 10 percent “base” tariff on most trade (oil is excluded, as is USMCA-compliant trade within North America) has some characteristics of a consumption tax. The gigantic current tariffs on China won’t generate any real revenue in the long run, but it isn’t unreasonable to expect that a 10 percent tariff on, say 7 percent of U.S. trade will generate a modest long-term revenue stream. The 25 percent sectoral tariffs on steel, autos, pharmaceuticals and semiconductors—collectively around 3% of GDP even without counting the embedded semiconductors in U.S. electronics imports—should generate a bit of revenue in the short run. Absent any offsetting tax cuts and even after considering the impact of routing trade around the tariffs, the tariffs would likely generate a fiscal consolidation of over 1 percent of U.S. GDP.  The resulting expected slowdown has led the market to expect that the Fed will cut the U.S. policy rate, which makes it less rewarding to hold short-dated U.S. financial assets.

2. A recession isn’t good for U.S. equities, and a lot of foreign investors now hold as many equities as bonds

Many analysts now expect a significant downturn in the U.S. in Q2 and Q3. That should be bad for equities, and the long-run impact of the tariffs on certain stocks is unlikely to be positive. Apple, for example, now faces a 20 percent tariff on phones imported from China (from the “fentanyl” national security case) and a 10 percent tariff on phones imported from India, with the risk of more tariffs. Those phones now arrive at U.S. customs at a price of $400 to $550 (the retail price is obviously higher, but Apple applies its markup on U.S. sales after the phones cross the border). That is a $40-$110 tax per iPhone. Some of that will be passed on to consumers, but some will be absorbed out of Apple’s margins. Apple’s challenge is modest compared to the problems faced by firms that have to pay the (for now) 125 percent “reciprocal” tariff on imports from China as well as the 20 percent IEEPA/fentanyl tariff. Demand for U.S. assets wasn’t, in fact, constant in the face of the tariffs, as the tariffs have an impact on the value of certain U.S. assets. 

3. China held the line.

Trump's first  term trade war was largely directed at China, and China responded to tariffs by letting the yuan slide. That was a relatively easy pressure valve to release back in 2018 and 2019, as the yuan started the trade war at a relatively elevated value (6.4 to the dollar or so) and China was comfortable letting the yuan fall to 7 or even a bit beyond. A weak yuan in turn led other Asian currencies to fall in sympathy.

But with the yuan already at long-term lows (around 7.3) China has been reluctant to allow the yuan to move—and risk disrupting the (modest) rally in Chinese assets observed in 2025.

China also may now think that it is better to make sure that U.S. importers don’t get a discount on Chinese goods… or simply be happy to allow the current weakness in the dollar to pull the trade-weighted renminbi down. Whatever China’s motive, the absence of a political decision by China to put the yuan back in play helped limit dollar weakness.

4. Europe got a vote.

The initial Trump trade assumed, more or less, that Americas trading partners wouldn’t change their policies in ways that made their currencies more attractive. That turned out to be wrong. Germany dropped its policy of self-imposed austerity—and allowed more borrowing for both investment in its security and investment in its infrastructure. Sweden too. Even the Irish are reportedly now ready to spend a bit more on defense. Fiscal easing in Europe’s previously frugal North should help support European growth—and also increase the supply of the most desired Euro-denominated financial asset (supply of “bunds”—long-term bonds issued by Germany’s federal government—previously fell well-short of global demand for euro-denominated foreign exchange reserves, let alone global demand for European safe assets from both public and private sources).

5. Trump’s America First (or “America Alone”) policies have diminished the global appeal of the dollar.

Trump (perhaps surprisingly) wants the dollar to remain the world’s reserve currency.* But his reckless initial tariffs and threats against American allies have potentially introduced a bit of a risk premium into dollar assets (or a bigger term premium into U.S. Treasury bonds). A U.S. that trades less makes holding an asset that is accepted by the dollar payment network worth a bit less (even if the dollar can still be used to settle payments between third parties). And if U.S. allies fear that they might be coerced by an “America first” President to pay for the security provided by an alliance with the U.S. through a tax on their U.S. holdings, well, that makes dollar claims on the U.S. a bit riskier.

Additionally, some big state institutions potentially face pressure not to invest quite so much in the U.S. if the U.S. is threatening their home institutions. If the U.S. isn’t going to respect Canada’s independence, should Canadian public pensions be so invested in the U.S.? If the U.S. isn’t going to respect Danish sovereignty, should Danish pensions and reserves be invested in dollars? Will Norway (which has a big sovereign wealth fund) and Sweden (which has large public pension funds) stand by their Scandinavian neighbor? There are lots of stockpiled legacy surpluses in Europe as well as in Asia.

There is, of course, the question of whether a China that no longer trades with the U.S. will continue to keep 55 percent of its formal reserves (see SAFE's 2023 annual report) and a much higher share of the foreign currency asset base of its state banks in dollars.

In a sense, the dollar’s recent weakness is over-determined.

There is also the simple fact that the dollar was exceptionally strong and thus the odds were that it would fall at some point. The flow equilibrium around the dollar required ever increasing inflows from the rest of the world at ever more inflated values of the dollar and U.S. equities—the so called U.S. exceptionalism trade.

And that trade was starting to show its age even before election of Donald Trump (see James Aitken). 

The 2023-24 dollar was at a level that implied an ever-shrinking U.S. export base.

It was also at a level that implied an ever-growing trade deficit.

Dollar strength was even weighing on the offshore income streams generated by America’s world leading digital platform companies—IP exports and FDI profits were falling as a share of U.S. GDP.

But the dollar’s downturn was still a bit of a surprise.

What’s more, even with the recent slide, the dollar is still quite strong by almost all measures.

CNY 7.2, KRW 1400, JPY 140; anyone who remembers the dollar’s levels against the big Asian currencies five years ago would say that these aren’t “weak” levels for the dollar (notwithstanding the somewhat exaggerated claims that float around about the end of the dollar’s global reign).

In some sense, though, the main constraint on dollar strength is that the most trade-exposed countries in Asia are themselves facing a big shock, and unlike Europe, they don’t seem committed to a big fiscal response.

They thus face a bit of a dilemma if their currencies rise from the repatriation of past investments and hedging flows even as global trade slows.

Taiwan is a great case in point. Private Taiwanese investors have built up a massive holdings of dollar assets (mostly bonds, and heavily corporate bonds) and they generally haven’t hedged that exposure (hedging has been expensive, and it is difficult for the world as a whole to be hedged against the dollar when the U.S. funds its external deficit in dollars).

And thus hedging flows from over-extended life insurance companies could put upward pressure on the Taiwan dollar, as on Monday. The real question then becomes how much dollar weakness is too much for Taiwan’s central bank (The Central Bank of China) and how will the United States Treasury respond if Taiwan engages in large scale, one sided intervention in the foreign exchange market to curb pressure on the Taiwan dollar to appreciate, and in the process keep the dollar artificially strong?

This story isn’t over.