USD can’t have it all

As the global tariff war wages on, businesses dealing in international trade are set for a prolonged period of uncertainty. The ongoing war ignited by Donald Trump resembles a high-stakes boxing match – one that’s set to go the full 12 rounds.

Imagine two of America’s most iconic fighters: Floyd Mayweather, an agile middleweight with unmatched speed and strategy, yet didn’t have a knock-out punch, and Mike Tyson, the fearsome heavyweight who relied upon force to dominate the ring for many years. These two styles mirror the roles different currencies play on the global stage.

The USD is undoubtedly the Tyson of international finance – powerful, dominant, and a leading force in global trade and investment. In fact, 50% of all global transactions are made in USD, and it’s the reference currency for the prices of all important commodities, such as gold, oil, and copper. That same dominance applies to investments, including foreign exchange reserves held by Central Banks and global bond markets. In international foreign exchange or currency markets, the dominance of USD is even bigger.

If that isn’t enough, the USD is the currency by proxy for many countries who have tied their own currency to it. Among those is a number of important economies such as the United Arab Emirates, Saudi Arabia and Qatar which means the actual weight of the USD can be increased by the relative importance of all those USD-pegged currencies. So, it is fair to say that no other currency comes close to the USD’s weight and strength.

However, in the current climate of economic tension and trade disputes, agility may trump raw power. When it comes to international trade, it pays off to be a middleweight. You don’t want a currency which is weak, but one which is light. Light in the sense that it is not too highly valued compared to your main trading partners.

The USD has (or should we say had) been performing very well against other currencies, such as EUR or GBP – among others due to the special status it has to attract investments. But a strong currency means that your exporters face a competitive disadvantage in the market they operate in, and that local manufacturers are vulnerable in their local market compared to foreign competitors.

So, Donald Trump, and the US, want their currency to be the centre of the world, and for it to have the “special” USD status. At the same time, they want to keep USD from becoming too overvalued in order to improve their positioning with global trading partners – and potentially have a better starting position in any trade wars.

In the last few weeks, we have seen the USD go from one state to the other, moving very quickly from a position of strength, towards a slide against GBP, EUR, and other currencies. It is clear the greenback hasn’t made up its mind whether it wants to be in the heavyweight or rather in the middle-weight division. But one thing is clear, the laws of physics dictate that it can’t have both.