Trump's Iran War And The Dollar Damage Done

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As the war in Iran threatens to trigger a 1970s-level inflation surge, Trump has been weakening the institutions charged with maintaining price stability. Case in point: Trump's unrelenting push to morph the Fed into the US equivalent of the People's Bank of China.

Through Trump put the moves on the Fed during his initial 2017-2021 presidency, the Trump 2.0 gang has really turned up the heat.

First, by trying to fire - or indict - Fed Chair Jerome Powell. Next, by trying to remove Fed Governor Lisa Cook. Then by adding Trump loyalists to the Fed board, including Trump's White House economist Stephen Miran.

A MAGA-fied Fed could be a nightmare for the global financial system, despite efforts to replace the dollar and US Treasuries as the linchpin of the global economy. The risk is that Trump's policies spook officials in Tokyo and Beijing, overseeing a combined US$1.9 trillion in US government debt.

In January, Deutsche Bank angered US Treasury Secretary Scott Bessent after one of its strategists warned foreign investors could leverage US holdings against Trump's threats against Greenland, or to retaliate against his reciprocal tariffs.

In the first year of his second term in office, Trump has indeed busily set out to trash trust in the dollar. He has pushed the national debt above $38 trillion, attacked the Fed, imposed heavy tariffs on friends and foes alike, and shook up the globe with geopolitical adventurism run amok.

These policies and others have the dollar and US Treasury yields in electrocardiogram mode. Officials in Beijing - particularly at the PBOC - worry about the safety of the combined $950 billion in US Treasuries held by Beijing and Hong Kong.

UBS economist Paul Donovan noted that even if China isn't threatening to dump official holdings of US dollars,“the idea that international investors may be less inclined to buy US Treasuries in the future (without dumping existing holdings) is getting attention in markets.”

That could change as Iran war fallout complicates Trump's designs on a weaker dollar, catalyzing a bigger standoff with the Fed. So far, in spite of Trump's fiscal exploits at home, the dollar is still playing its traditional role as safe haven, keeping the US exchange rate stronger than Trump would prefer. Especially now that US employment is weakening in real time.

In February, US payrolls dropped a surprising 92,000 and the unemployment rate ticked up to 4.4%. As Trump's Iran“excursion,” as he calls it, propels inflation higher, the latest employment“numbers may have put the Fed between a rock and a hard place,” notes Ellen Zentner, strategist at Morgan Stanley Wealth Management.

Powell's term ends in mid-May. Trump had been hoping that his pick to replace him, Kevin Warsh, would push for big rate cuts right out of the gate. That's now very much in question.

Trump's preference rate, closer to 1%, may face strong pushback. The minutes of the January Federal Open Market Committee indicated that“several” members thought rate hikes might be needed. The hawks are gaining power as the fallout of the Iran war on the inflation outlook mounts.

It's not clear, though, that Trump will be patient. In January, he proposed that government-sponsored enterprises Fannie Mae and Freddie Mac purchase $200 billion in mortgage-backed securities.

It's the sort of financing role the Fed would perform in times of credit market distress. Trump's proposal, which appeared to be an attempt to end-run around the Fed to weaken the dollar, struck many as a way to revive quantitative easing. Economist Mohamed El-Erian at Allianz calls it the“people's QE.”

Trump's campaign for a weaker dollar also suggests he knows little about how Japan's now-decades-long weak yen policy is backfiring on Asia's No. 2 economy. Part of the problem is Trump's 1985 mindset. Back then, the top industrialized nations could agree in a New York Plaza Hotel ballroom to weaken the dollar.

Forty years later, his desire for a“Mar-a-Lago Accord” seeks to recreate a global trade dynamic that no longer exists. Not when so much of the global wealth needed to command markets is in the broader BRICS (Brazil, Russia, India, China, South Africa) universe, including oil-rich states such as Saudi Arabia and the United Arab Emirates.

Even so, Trump's top economic officials, including Bessent, clearly haven't schooled him on why the exorbitant privilege that Washington enjoys, including the ability to issue debt at markedly low yields, is such a plus for America.

Might all this come to a head in 2026? Even the May decision by Moody's Investors Service to revoke Washington's last AAA rating caused little more than a ripple in debt markets. The reaction was that the dollar, for better or worse, remains the global system's primary currency, despite intensifying efforts to find alternatives. For now, at least.

Xi Jinping's China, meanwhile, sees an opportunity to position Asia's biggest economy as a more reliable and pro-trade superpower. More and more, Team Xi Jinping probably can't believe its lucky stars as Trump sabotages the globe's biggest economy and a currency China aims to replace.