The Falling Dollar

Caitlin McCabe, writing for The Wall Street Journal, reports that the ICE U.S. Index has declined more than 10% in 2025, the largest drop since 1985. She lists three reasons for the decline: President Trump’s tariff policies, fears that the Federal Reserve will lose independence, and growing concern over U.S. government debt. Her list is on the mark, and Trump owns two of the three reasons. He caused them. The third reason, the debt, Trump shares with his recent predecessors, despite his attempt to take sole possession of this reason with his budget deal. I will focus on one of the three causes for the decline in the value of the dollar: Trump’s tariff policy, which is intentionally designed to devalue the dollar, but first I measure the drop of the dollar using two graphs derived from the Nominal Broad U.S. Dollar Index data series (DTWEXBGS) curated by the Federal Reserve Bank of St. Louis. 

The first graph (below) plots the value of the dollar from January 20, 2025, when Trump took office, until July 11, 2025. It is similar to the graphs that have circulated in other articles, although the exchange rate indexes vary; like the others, it shows a significant decrease, with this index showing a 6.43% decline since Trump began his second term.

The second graph (below) plots the value of the dollar over a longer horizon, beginning on July 1, 2007. The graph is placed beneath this paragraph. The green line again represents the exchange rate. The vertical lines represent the beginning of a presidency, with Democrats in blue (Obama, then Biden), and the only Republican, Trump, whose discontinuous first and second terms are in red. The gray rectangles highlight the Great Recession, and to COVID recessions. My numerical analysis begins on January 1, 2009, day after President Obama took office. The first observation is that, although the exchange rate has fallen, it starts at its highest value over the 16.5-year period. The exchange rate remains high, higher than 83.42 days during the entire period. The second is that the exchange rate increased under Obama’s two terms (15.88%), and Biden’s single term (16.35%), while it decreased during Trump’s first administration (-4.94%), slightly less than the 6.43% decline to date in his second term. The dollar is falling because that is Trump’s goal.

The president has long believed that tariffs can stop other countries from “cheating” the U.S. in trade. Stephan Miran, Trump’s Chairman of the Council of Economic Advisors, has developed a theory that supports the president’s position. He believes that it is costly to the United States for the dollar to be the world’s reserve currency, and that the president can eliminate the cost by imposing tariffs on other countries if they don’t retaliate (See CEA Chairman Steve Miran Hudson Institute Event Remarks, The White House, April 7, 2025). 

 A falling dollar reverberates through the economy, as a couple of examples will make clear. Consumers who buy imports will pay more. If an imported product, such as an SUV, has an American substitute, like a Ford produced in Michigan, the American manufacturer and its suppliers, including labor, will benefit. The consumer is likely to pay more for the Ford than the pre-tariff foreign SUV. If you like bananas or coffee, you are out of luck. You will pay more. American firms that export products and their suppliers will find their products are cheaper in foreign markets relative to competing products. 

 Because interest rates increase when the dollar falls, the most significant cost to Americans might be the interest on the debt. Combined with the larger deficit caused by the One Big Beautiful Act, interest payments will grow absolutely, and as a percentage of the total budget. The probability of the U.S. defaulting on its debt obligations will also increase, potentially introducing an era of stagflation characterized by high inflation and low economic growth. 

Will Trump’s tariffs, supported by Miran’s theory, bring renewed vigor to the American economy? Kenneth Rogoff, the coauthor with Carmen Reinhart of “This Time is Different: Eight Centuries of Financial Folly,” argues that it will not. Writing “Miran’s plan, clever as it might be, is based on a flawed diagnosis. While the dollar’s role as the world’s leading reserve currency plays a part, it is just one of many factors contributing to the United States' persistent trade deficits. And if the trade deficit has many causes, the idea that tariffs can be a cure-all is dubious at best” (Kenneth Rogoff. "Trump’s Misguided Plan to Weaken the Dollar,” Project Syndicate, May 6, 2025.

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Current Governments and Concurrent Economic Performance

I estimated real GDP growth by presidential administration, spanning from Reagan's first term to the first quarter of Trump's second term, using the FRED database series NGDPRSAXDCUSQ, which measures real GDP. For those interested in the mathematical details, I calculated the geometric annual growth rate between the last quarter the administration was in office and the quarter it took office.

Growth was highest during Clinton’s second administration (4.1%), followed by Reagan’s second administration (3.6%). Ignoring the one quarter of data for the second Trump administration (-0.3%), growth was lowest during George W. Bush’s second administration (1.0%), followed by Trump’s first administration (1.7%). Many administrations fell between the two best and the two worst.

Voters have a natural tendency to associate their favorite elected official with positive economic performance, and real GDP growth is undoubtedly a key statistic. Our politicians nourish this tendency by taking credit for good economic news and, of course, blaming political opponents for bad economic news. It takes time for the government to implement fiscal policy, and even more time for it to have an impact on economic activity. A policy can have both short-term benefits and long-term costs, or vice versa.

Politicians ignore another essential feature of our market economy. Markets generate their momentum, which might cause a downturn or a boom, but the tendency is towards full employment. Good policy may augment growth and mitigate market downturns, while bad policy has the opposite effect; however, policy is generally overwhelmed by market forces.

Economists don’t take the political bait. Nearly all believe that current policy is not the cause of current economic outcomes. Do voters bite when economists don’t? The European IGM Economic Experts Panel was asked to respond to the statement, “Voters overestimate the effect that current governments have on their economies’ concurrent economic performance.” Sixty-four percent of the respondents strongly agreed or agreed, whereas only 4 percent strongly disagreed or disagreed. Six percent were uncertain, while 4% held no opinion, and the remaining 22 percent did not answer the question. An alternative to evaluating performance by examining macroeconomic statistics is to assess the likely impact of policies. There is little new under the sun. A policy enacted today has been tried elsewhere, and economists have measured its impact. Reviewing their conclusions is an effective way to evaluate an administration's performance.   

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Economists Are Pro-Market, Not Pro-Business

President Trump’s inauguration featured a conspicuous display of billionaires. Elon Musk, Jeff Bezos, Mark Zuckerberg, Sergey Brin, Sam Altman, and a host of others, whose wealth collectively tops $1.35 trillion, attended the day’s festivities. Trump’s association with them did not end that day. He appointed thirteen billionaires to high office. I don’t even know thirteen billionaires! The ostentatious display of wealth and entrepreneurial talent feeds the conservative narrative that the Republican Party is pro-business and that business leaders are uniquely qualified to manage the economy. This belief is wrong. 

 At the heart of economics is a counterintuitive proposition first articulated by Adam Smith, which defines it as an academic discipline: that everyone, by pursuing their interests, ultimately results in the public good. Vilfredo Pareto refined this proposition, convincingly arguing that competitive markets yield an equilibrium, a stable point of production and consumption, in which no one can be made better off without making another worse off. There are strings attached. Markets must be complete, have perfect information, and have no externalities. I illustrate the implications of the theorem using a circular flow diagram, explaining that pro-market policies trump pro-business policies because they generate higher income, or, alternatively, higher-valued output. In short, pro-market policies yield a higher level of societal well-being for market participants. Economists are pro-market, not pro-business.1 Policy makers would do well to pay heed to this intuition.

The circular flow diagram assumes two types of economic agents: households and firms (represented by the red ovals). Households own all the resources, which economists generally categorize as land, labor, capital, and entrepreneurship. Firms combine these resources into outputs categorized as goods and services. Agents trade resources in the market for resources (represented by the lower blue rectangle), and goods and services in the market for goods and services (represented by the upper blue rectangle). The circular flow diagram has two types of flows from economic agents to markets. The flow of tangible objects, resources, goods, and services is represented by the orange arrows, which move in a counterclockwise direction. The second flow is financial. It records the payments for resources, goods, and services, represented by green arrows moving clockwise.

Households take resources to market, illustrated by orange arrow 1A. Firms take the resources from the market, illustrated by orange arrow 1B. The financial flow moves in the opposite direction. Firms pay households for resources in the resource market; green arrow 2B shows the financial flow from the firm to the market, and green arrow 2A shows the financial flow households take from the market to the household. Each type of resource receives payment. Land receives rent, labor receives wages, capital receives interest, and entrepreneurship, which combines all the resources into goods and services, receives profit. Household income, the sum of rent, wages, interest, and profits, equals exactly the expenses of firms for the resource.

Having described the nature of the two flows between economic agents in one market, I can be more succinct in describing the flows between agents in the other market. Firms produce goods and services for markets where households buy them. The orange arrows 1C and 1D illustrate the physical flows, while the green arrows 2D and 2C represent the financial flows.

The flow of resources, goods, and services to markets and the financial exchanges for them may seem routine and dull. It is anything but. They are tumultuous. Joseph Schumpeter described them as the “perennial gale of creative destruction.” Entrepreneurs want more than the profits earned in competitive markets where they are unable to influence price. Their exertions create winners and losers. Robots and AI continue to replace workers, who then struggle to find remunerative employment. Burgeoning trade with China shuttered factories in the Midwest but created jobs in technology centers near great universities, such as those in Seattle, Silicon Valley, Boston, and Austin. Does anybody miss Ma Bell? An antitrust settlement hamstrung her, and smartphones finished the job.

Market competition hampers the ethically challenged, but they still manage to plague markets. Enron employed fraudulent accounting practices to conceal debt and inflate profits. WorldCom’s CEO, Bernard Ebbers, inflated profits by nearly $3.8 billion through capitalizing operating expenses. An internal audit by Cynthia Cooper discovered and revealed fraud. Burdened by high debt, the company filed for bankruptcy. BP’s Deepwater Horizon drilling well would have given the company access to 50 million barrels of oil valued at $5 billion. Shortly before the well went online, it failed a critical safety test. The company covered up the failure, leading to an explosion that caused the largest oil spill in U.S. history.

According to the First Welfare Theorem, total payments are maximized when markets are so competitive that entrepreneurs must accept the prices set by markets. When entrepreneurs set prices, they extract rents, wages, and interest from the other factors of production. Income falls. Having a government that does not keep an eye on entrepreneurs, and two as often as they can, is bad enough. Giving entrepreneurs the reins of government is like giving them the key to the candy store. Most entrepreneurs are honest, but they tend to see all problems through the eyes of an entrepreneur. Entrepreneurs do not need to run the government themselves. They can elect pro-business politicians who share the same predilection to maximize profits at the expense of other sources of income. The first welfare theorem compels economists to be pro-market, rather than pro-business. Voters should demand that the government at all levels be pro-market.  

1. See the "About ProMarket" at ProMarket - ProMarket.

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Remembering Joseph S. Nye Jr.: An Ad Hoc Test of Soft Power

Joseph S. Nye Jr. passed on May 6, 2025. Unless you have studied international relations, you probably never heard of him, but you have heard of his ideas. He coined the term soft power, using diplomacy, cultural influence, and persuasion to achieve policy objectives over a prolonged period. Scholars and diplomats distinguish soft power from hard power, which uses military and economic force to achieve goals. He taught that hard and soft power are more effective when combined to create smart power, using strategic alliances, partnerships, and institutions to expand our influence and establish legitimacy in international affairs. He believed that soft power, properly applied, could reduce the overall cost of foreign policy by reducing the level of hard power needed to achieve objectives.

Nye summarized power and its use in a May 16, 2025, article by Project Syndicate titled “The Future of American Soft Power.” The Future of American Soft Power by Joseph S. Nye, Jr. - Project Syndicate

 “Power is the ability to get others to do what you want. That can be accomplished by coercion (“sticks”), payment (“carrots”), and attraction (“honey”). The first two methods are forms of hard power, whereas attraction is soft power. Soft power grows out of a country’s culture, its political values, and its foreign policies. In the short term, hard power usually trumps soft power. But over the long term, soft power often prevails. Joseph Stalin once mockingly asked, “How many divisions does the Pope have?” But the papacy continues today, while Stalin’s Soviet Union is long gone. 

 “When you are attractive, you can economize on carrots and sticks. If allies see you as benign and trustworthy, they are more likely to be open to persuasion and follow your lead. If they see you as an unreliable bully, they are more likely to drag their feet and reduce their interdependence when they can. Cold War Europe is a good example. A Norwegian historian described Europe as divided into a Soviet and an American empire. But there was a crucial difference: the American side was “an empire by invitation.” That became clear when the Soviets had to deploy troops to Budapest in 1956, and to Prague in 1968. In contrast, NATO has not only survived but voluntarily increased its membership.”

 The Kennedy administration created the U.S. Agency for International Development (USAID) in 1961. It became an essential part of the government's projection of soft power. On March 28, 2025, the Trump administration shut it down. The action has been contested. The status of USAID and its programs is being argued in the courts. 

 The Chicago Booth’s US Economic Experts Panel answered three questions about the impact of eliminating its programs. Foreign Aid - Clark Center Forum These questions do not directly test Nye’s theories, but I have shoehorned them as an ad hoc test. As a note, I eliminated the category “did not answer” and adjusted the results. The questions and responses are as follows:

Question A: The cancellation of the majority of programs run by the US Agency for International Development (USAID) will have no measurable effects on GDP growth in the recipient countries over the next five years.

Question B: The cancellation of the majority of USAID programs will have substantially negative effects on the most vulnerable people in the recipient countries over the next five years.

Question C: Development assistance motivated by the potential benefits for the donors in terms of prosperity and security is measurably more effective in promoting GDP growth in recipient countries than aid based on humanitarian or other moral principles.

The survey, which I had appropriated to test Nye's theory of soft power, might be interpreted as weakly supporting the theory. Most economists (51%) were uncertain about how ending USAID aid would impact the future GDP growth of recipient countries. Thirty-five percent believed removing aid would impact future growth, and 12 percent thought it would not. Nearly all the economists believed that the USAID aid achieved humanitarian objectives. Ninety-eight percent believed that removing the aid would “have substantially negative effects on the most vulnerable people in the recipient countries over the next five years.” Is hard power, carrots and sticks, more effective for donor nations than soft power, honey? Most economists, 54 percent, were uncertain. Thirty-four percent believed it is not. None of the economists surveyed thought that hard power is more effective. Twelve percent offered no opinion.

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Update of the Impact of Current Policy on Concurrent Growth

In this post, I update the November 24, 2018, “Current Policy and Concurrent Economic Performance.” Economists overwhelmingly believe that current economic policy has little to do with concurrent economic performance, yet voters look to current economic performance as a metric of the success or failure of an administration’s policies. For evidence of my claim, see the European IGM Economics Expert Panel’s response to the statement, “Voters overestimate the effect that current governments have on their economies.” Sixty-four percent of the respondents strongly agreed or agreed whereas only 4% strongly disagreed or disagreed. Six percent were uncertain, while 4% held no opinion, and the remaining 22% did not answer the question. Expressed slightly differently, 82% of economists responding to the statement believe that voters overestimate the effect. Politicians certainly tie positive outcomes to their policies. As an example, President Trump trumpets his economic successes (“Trump Says U.S. Economy is ‘Best It Has Ever Been,’ But Facts Tell a Different Story”), while blaming others for failures, or even possible failures (“'Crazy Inverted Yield Curve!'—Trump rips 'clueless Jay Powell' and the Fed as the market slides”).

To check claims of the “best economy every,” I have used a single metric, real GDP growth by quarter beginning with the first quarter of 1981 under President Reagan and continuing through the second quarter of 2019 under President Trump. The data is presented as a bar chart in the first graph. Republican presidents are in red, and Democrats in blue. Second terms are represented by light red or light blue. Fluctuations in growth appear to have moderated. The U.S. has not experienced a quarter of economic decline during the Trump presidency, nor has it experienced a quarter of high growth.

I present the data as unconnected points in the second graph. Republican presidencies, with the exception of the Trump presidency are shown in red, and Trump in purple while Democratic presidencies are shown in blue. I have also added three horizontal lines that represent average growth (black), two standard deviations above average growth (purple), and two standard deviations below average growth (blue). Average growth for all presidents is 2.74%. Average growth for all Republicans is 2.64 and for Democrats is 2.86. Average growth under Trump is 2.64%, the mean level of growth for all Republicans, and the economy has not experience a quarter of exceptionally high (two standard deviations above the mean) or low (two standard deviations below the mean) growth during his presidency. Observing that current policies and concurrent economic performance are exaggerated by voters does not imply that current policy does not have an impact on economic performance. It does imply that the impact is difficult to disentangle the impact of a policy from all other influences. Without offering evidence, I believe that the most important contributors to current economic performance are individual economic agents each maximizing their own welfare through markets.
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Capitalism and Democracy

Pete Buttigieg, a presidential candidate for the Democratic Party, appeared recently on CNN’s “New Day” with Poppy Harlow and John Avlon. He commented on socialism, capitalism, capitalism’s relationship with democracy, and criticized Stephen Moore, a Trump administration nominee for the Federal Reserve Board of Governors, for a comment he made on the same subject. I attempt to bring more context to both men’s statements. Please note that I am not digging into other statements on this subject that might give additional context. Although the interview was with CNN, Tom Boggioni, in RAWSTORY, provided the best transcript that I found. I edited Boggioni transcript a bit, eliminating editorial comments that bridged sentences, and one error in transcription. Harlow asked if Democratic office holders have vilified capitalism to a dangerous level given that most Democratic voters view socialism more favorable than capitalism. Buttigieg said,

“I think the reason we’re having this argument over socialism and capitalism is that capitalism has let a lot of people down. I guess what I’m out there to say is it doesn’t have to be so.” “I believe in democratic capitalism, the democratic part is extremely important. There was this assumption that capitalism and democracy were almost the same thing — if you were for capitalism, you were also for democracy. Right now, we see democracy and capitalism coming into tension.”

Overall, Buttigieg gave a good answer, much better than I expect from a presidential candidate, but there were a few problems with it. First off, he did exercise discretion, and discretion is generally good, by not criticizing fellow Democrats, but he evaded the question, not responding to directly to whether Democrats in office have excessively vilified business and capitalism giving rise to a preference for socialism among Democrat voters. He did say that capitalism “has let a lot of people down.” This is true, but so has socialism. Comparatively speaking, competitive capitalism has a much better record than socialism. As noted by Milton Friedman in an interview with Phil Donohue,

“In the only cases in which the masses have escaped from the kind of grinding poverty you’re talking about, the only cases in recorded history are where they have had capitalism and largely free trade. If you want to know where the masses are worst off, it’s exactly in the kinds of societies that depart from that. So that the record of history is absolutely crystal clear that there is no alternative way, so far discovered, of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system.”

Buttigieg is correct to limit his praise to democratic capitalism. The success of capitalism to create long-run prosperity seems to be limited to those countries that combined democratic and market institutions. The two can work to strengthen each other. Economists have emphasized this relationship in their empirical findings after Friedman made his statement. While I disagree with Buttigieg’s wording, “we see democracy and capitalism coming into tension,” he certainly captures the mood of many voters. To be clear, democracy and capitalism are not people; they don’t make decisions and they don’t experience tension. Focusing on economic agents is more productive than ascribing human characteristics to institutions. Politicians from both parties, combined with politically empowered businesspersons, have designed law to benefit each other to the detriment of large groups of voters. Buttigieg brought one of President Donald Trump’s advisors, Stephen Moore, into the fray.

“It was alarming to hear recently one of the president’s economic advisers [Fed nominee Stephen Moore] said between capitalism and democracy, he’d choose capitalism.”

It is easy to pick out part of a quote and criticize the originator for it. As best I can tell, the quote is from Michael Moore’s documentary, Capitalism: a Love Story. The full quote reads,

“Capitalism is a lot more important than democracy. I’m not even a big believer in democracy. I always say that democracy can be two wolves and a sheep deciding on what to have for dinner. Look, I’m in favor of people having the right to vote and things like that. But there are a lot of countries that have the right to vote that are still poor. Democracy doesn’t always lead to a good economy or even a good political system.”

Just as Buttigieg focuses almost exclusively on the weakness of capitalism in its interaction with democracy, Moore almost exclusively focuses on the weakness of democracy. Sure, there are a lot of countries with some democratic institutions that are poor, but all wealthy countries have successfully combined democratic and market institutions to become so. Unlike Bittigieg, in this particular quote Moore does not recognize the positive outcomes when they two types of institutions operate together.
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Current Policy and Concurrent Economic Performance

Among people interested in politics, there is a natural desire to discover a positive relationship between their favorite party and good economic performance. I shared this belief, and it only faded slowly after many years of studying and teaching economics. Why shouldn’t many people share this belief? Our politicians certainly encourage it, taking credit for positive outcomes, and blaming opponents for negative outcomes. I have accumulated data on quarterly real GDP growth from the Reagan administration through the first two years of the Trump administration, and presented the data in a series of graphs to informally test the hypothesis that current policy influences current economic performance. As a note, fourth quarter 2018 growth during the Trump was estimated by the Atlanta Federal Reserve.

The first graph shows the quarterly growth of real GDP by administration from 1981 to the present. The data in red demarks the first term of a Republican president, and the data in blue, a Democrat president. Likewise, the light red reflects the second administration of a Republican president, and the light blue, a Democrat president. I could not visibly determine a difference in outcomes by party. Other readers may pick up trends that I missed.

The first histogram displays real GDP growth 88 quarters (22 years) of Republican administration and 64 quarters (16 years) of Democrat administrations. The red is the Republican, the blue, the democrat, and the purple, the overlap between the two parties. There are differences in the performance between the two parties. Republican administrations seem to have weathered the most severe downturns, and enjoyed the highest levels of economic growth. More striking is the overlap. The red represents the histogram of Republicans and the blue and purple, the Democrats. The distribution of growth between the two parties center around the same mean, 2.7 for the Republicans and 2.9 for the Democrats.

Picking on President Trump because he is the current president, and because he recently asserted that second quarter 2018 growth is “an economic turnaround of historic proportion,” the second histogram separates the Trump administration figures from the other Republican administrations. Growth to date for his administration averages 2.8%, splitting the difference between Democrats and other Republicans.

The final graph places real GDP quarterly growth by administration along with the average level of growth, and both a two standard deviations upper and lower band. Growth during the Trump administration is nothing out of the ordinary. It centers around the mean and does not approach the two standard deviation threshold. While disproving President Trump’s claim of historic growth, it also dispels the notion that Trump’s policies have already ruined the economy. 

The fact that current policies do not seem to immediately influence economic outcomes is not my belief alone. The European IGM Economic Experts Panel was recently asked to respond to the statement, “Voters overestimate the effect that current governments have on their economies’ concurrent economic performance.” Sixty-four percent of the respondents strongly agreed or agreed whereas only 4% strongly disagreed or disagreed. Six percent were uncertain, while 4% held no opinion, and the remaining 22% did not answer the question. As an aside, several of the economists surveyed offered valuable comments. 

There are many reasons why policy seems to have no immediate impact. We participate in a market economy, and the independent actions of economic agents attempting to maximize their outcomes might overwhelm the actions of any president or party. Perhaps policy of both parties is more similar than different. Autonomous agencies, like the Federal Reserve, might have more impact than presidential administration. Professional bureaucracies that span administrations may act as a ballast to policies that deviate from norms. Finally, both good and bad policies might take time before their impact is realized, and might not be easily associated with a past administration, suggesting that policy is important, but its impacts are often not immediate.

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