Is the U.S. Steering Toward a Weaker Dollar?

Last week’s storm in the financial markets was largely triggered by reciprocal tariffs announced by the U.S. President on several countries. In response, some of the targeted countries retaliated. On April 4th, China’s Ministry of Finance announced it would impose tariffs of 34% on all U.S. goods. This reignited fears in the markets, resulting in a broad sell-off across the U.S. dollar, equities, and commodities.

Has there been a time of Dollar Weakness Before?

Let’s take a step back in history. In 1985, a landmark agreement known as the Plaza Accord was reached between the world’s major economies to deliberately devalue the U.S. dollar. The participants at the time, the G5 (U.S., Japan, West Germany, France, and the U.K.) sought to correct the dollar’s excessive strength, which was hurting U.S. exports and contributing to a massive trade deficit. At the time, the U.S. was also battling stagflation, with inflation running in double digits.

Within two years, the USD/JPY dropped from 240 to 120 (a 50% decline), while the U.S. dollar fell around 45% against the German mark. Japan, often likened to China today, had seen its highly competitive exports dominate global markets. The goal of the accord was to make Japanese goods more expensive for U.S. consumers by weakening the dollar. Although Japan agreed under pressure, the long-term effects were painful leading to prolonged deflation and economic stagnation.

Will History Repeat Itself?

Today, some speculate about a modern-day Mar-a-Lago Accord named after President Trump’s Florida resort. Is the U.S. once again pursuing a weaker dollar?

If so, the implications could be significant. A weaker dollar would reduce the trade deficit by making U.S. exports cheaper and imports more expensive. It would also affect U.S. government bonds, since their value is denominated in dollars, a weaker dollar effectively reduces the debt burden in real terms.

For example, a U.S. product priced at $10,000 might have cost a European buyer roughly €10,000 just a few months ago. If the dollar drops 20%, the same product will cost only €8,000, making it more attractive to foreign buyers, while discouraging Americans from purchasing foreign goods.

Could China Follow Japan’s Path?

Looking at China’s current positioning, it appears they've learned from Japan’s experience in the 1980s. Since 2021, China has reduced its U.S. Treasury bond holdings from $1.1 trillion to around $760 billion by 2024. Simultaneously, its gold reserves have increased from 63 million ounces in 2020 to 73 million ounces in 2024.

Conclusion

China seems to be actively reducing its exposure to the U.S. dollar, possibly to avoid the long-term consequences Japan faced post-Plaza Accord. By lowering its holdings of U.S. Treasuries and increasing gold reserves, China is positioning itself to withstand potential dollar devaluation.

In today’s climate of economic uncertainty and rising geopolitical tensions, especially with the resurgence of tariffs, should investors brace themselves for continued volatility? Might it be wise to wait for a clearer picture before making major decisions in the financial markets? Only time will show how these factors will unfold.