Are we on the brink of a US dollar crisis?

In the wake of Donald Trump’s announcement of sweeping ‘liberation day’ tariffs, the US dollar crumbled. The dollar index – which measures the currency against a basket of its rivals – plunged over 2%, striking its lowest level in six months.

The downfall of USD came amid rising fears of a US recession due to the impact of tariffs. Concerns about the way the White House calculated the tariffs also undermined confidence in the ‘greenback’, as analysts around the world started questioning the administration’s policy credibility.

Meanwhile, the possibility of rising inflation could put the White House and the Federal Reserve on a collision course, stoking fears that Trump might challenge the central bank’s independence.

A US recession, failing confidence in American economic policy, and a threat to the Fed’s independence could spell a perfect storm for the ‘greenback’. But is it really possible that the US dollar could face a confidence crisis? Could ‘King Dollar’ be toppled?

Market turmoil and the US dollar’s safe-haven status

The unveiling of Trump’s tariffs sent global markets into a tailspin, which was then exacerbated by China’s retaliatory measures announced on Friday. Many stock indexes have suffered their worst losses since Covid crashed the markets back in 2020.

Meanwhile, we saw a flight to safety. Gold surged to a record high and the safe-haven Swiss franc enjoyed impressive gains, with CHF/USD jumping 4.4%. Government bonds also surged, with bond yields in the US, UK, Japan and Australia striking multi-month lows.

However, the US dollar – typically a safe-haven asset – plunged despite the risk-off market mood. This uncharacteristic movement was primarily driven by other fundamental factors, but it’s notable nonetheless as it suggests that cracks may be forming in USD’s safe-haven status – something that underpins the dollar’s dominance.

We saw similar movements in the run-up to the tariff announcement, with concerns about the US economy outweighing the dollar’s safe-haven appeal. If the post-tariff chaos continues, so could this trend.

American stagflation and recession risks

One of the key reasons the safe-haven dollar slumped despite the risk-off mood is the fear of what tariffs may do to the US economy.

Analysts have increased their chances of a US recession since Trump unveiled his tariffs. S&P Global raised their odds from 25% to 30%-35%, Goldman Sachs from 20% to 45%, and JP Morgan from 40% to 60%.

Other banks and research firms, such as Barclays, Deutsche Bank and UBS, have also warned of a higher risk of an American recession this year.

In addition, there are growing concerns about stagflation – that toxic mix of weakening growth and rising inflation. This would make it harder for the Federal Reserve to cut interest rates and therefore likely extend the economic pain. A recession, stagflation, or prolonged economic crisis could further erode the US dollar’s value and its status as a safer investment.

The current best-case scenario is if the US economy proves more resilient than anticipated, while tax cuts could also help to drive growth. And if Trump’s protectionist policies boost investment and the US negotiates targeted trade deals and tariff relief, then the US economy may weather the storm.

However, these outcomes are somewhat contingent on competent economic and monetary policy – and confidence in the White House is waning.

A US credibility crisis

As Trump announced his tariff regime in the White House Rose Garden, he referenced a large cardboard chart. The chart detailed what the Trump administration considered to be tariffs from other countries, alongside their own ‘discounted reciprocal’ tariffs.

However, these calculations had economists raising their eyebrows. Instead of using a sophisticated assessment of tariffs and other trade barriers implemented by individual countries, the White House used a blunt, mechanical formula that essentially divides the US trade deficit by the total imports from that country. Not only has this resulted in highly inflated tariff estimates, but it also appears to have undermined the credibility of the Trump administration.

Analysts at Deutsche Bank raised concerns about how the administration is approaching economic policy. Deutsche Bank said:

‘We worry this risks lowering the policy credibility of the administration on a forward-looking basis. The market may question the extent to which a sufficiently structured planning process for major economic decisions is taking place. After all, this is the biggest trade policy shift from the US in a century. Crucially, major additional fiscal decisions are lining up over the next two months.’

Another significant concern was that this blunt approach leaves little leeway for negotiations. Many commentators expected Trump’s tariffs to be a hardball negotiation tactic. However, the approach taken indicates a broad desire to reduce trade imbalances, rather than outlining areas for negotiation or hinting at specific policy requests. This has called into question the idea that Trump has a strategy in mind in terms of striking new trade deals.

Furthermore, the fallout from the tariffs could put the Federal Reserve and the Trump administration on a collision course.

There are fears that Trump may challenge the central bank’s independence, as he has called on the Fed to lower interest rates. The new tariffs could push up US inflation, thereby making it harder for the Federal Reserve to continue easing monetary policy.

On the Friday after the tariffs were announced, Fed Chair Jerome Powell raised concerns about longer-term inflation expectations. Powell said:

‘We face a highly uncertain outlook with elevated risks of both higher unemployment and higher inflation… While tariffs are highly likely to generate at least a temporary rise in inflation, it is also possible that the effects could be more persistent.’

Donald Trump responded with a post on Truth Social applying pressure on Powell:

‘This would be a PERFECT time for Fed Chairman Jerome Powell to cut Interest Rates. He is always “late,” but he could now change his image, and quickly… CUT INTEREST RATES, JEROME, AND STOP PLAYING POLITICS!’

Since then he has repeated his call for lower rates, with commentators speculating that Trump may have intentionally triggered a market crash to force an emergency rate cut from the Fed.

Speculation aside, the tariff chaos sets the stage for a potential showdown between the Federal Reserve and the White House. If rising US inflation prompts the Fed to hold or even hike interest rates, Trump may consider seizing control to start slashing rates. If anything could spark a crisis in the US dollar, this could be it.

Global realignment: Could rivals seize the moment?

America’s rivals have long sought to challenge the dollar’s dominance as the world’s de facto currency. China has been leading the charge, pushing the yuan in trade deals, building its own alternative to SWIFT, and striking currency swap agreements around the globe. Russia, too, has been on a de-dollarisation mission, ditching the ‘greenback’ in favour of roubles and yuan – especially since being hit with Western sanctions.

Even allies have grown uneasy with the dollar’s dominance. The EU has floated plans to bolster the euro’s global role, while BRICS nations continue to talk up new systems to sidestep the dollar altogether. For years, these efforts barely dented the dollar’s supremacy – but Trump’s latest tariff tirade could be the spark that sets a real shift in motion.

This is unlikely to happen overnight. These kinds of seismic shifts can take a very long time, and the immediate focus for many countries will be how they respond to Trump’s tariffs and adapt to a new global economic order. However, it’s precisely because of this new global economic order that we may see a faster shift to a multipolar monetary and financial system.

Central banks have been rethinking their FX reserve strategies in recent years, with some quietly diversifying by upping their exposure to gold, the euro, or even the yuan. Trump’s trade policies and fading confidence in the US dollar could accelerate this trend.

Yet for all the talk of diversification, central banks face a catch-22. The chaos that’s making them question their dollar exposure is the very thing making it harder to act. In times of turmoil, liquidity and stability are important – and that still means the US dollar. Selling off dollars too quickly could destabilise their own currencies or spark market panic. So while the desire to diversify is growing, many central banks may be forced to sit tight for now.

The recent dollar volatility – crisis or correction?

For decades, the US dollar has reigned supreme – the world’s reserve currency, safe-haven asset, and linchpin of the global financial system. Its dominance rests on powerful foundations: deep and liquid capital markets, relative political stability, and a lack of credible alternatives. Even during moments of crisis, the world has turned to the ‘greenback’ – not away from it.

And yet, this time feels different.

There is already a growing appetite for a more multipolar financial order. China, Russia, the BRICS bloc and even longstanding allies have been exploring alternatives, seeking to reduce their reliance on the dollar. Until now, these efforts have gained relatively little traction. But if confidence in US economic management starts to erode, those simmering ambitions could find fertile ground.

The worst-case scenario – unlikely, but not unthinkable – would be a deep US recession, sticky inflation and higher interest rates, followed by Trump seizing control of the Federal Reserve and slashing rates in defiance of economic orthodoxy. Add in failed negotiations and an escalating global trade war and you have the ingredients for a genuine dollar crisis.

Of course, that’s the extreme end of the spectrum. The US economy may yet prove resilient, and coming tax cuts and deregulation could limit the damage. Trump’s tariff policies could soften or shift, trade deals might materialise, inflation could moderate, and confidence could return.

The truth is, no one knows what path lies ahead – not least because of the inherent unpredictability of Donald Trump’s decision-making, and the uncertain reactions of global actors responding to shifting dynamics.

Still, the tide may be beginning to turn. While the dollar may avoid a full-blown crisis, Trump’s tariffs – and the uncertainty they’ve unleashed – are already eroding confidence in the ‘greenback’. This could prove to be a pivotal moment in the gradual shift away from the dollar-centric world order.

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