Goldman Sachs Chief Economist: The dollar will continue to fall, as long as the tariff war continues to decline, it is inevitable

Source: Wall Street Insights

Recently, the US dollar has depreciated by about 5% on a trade-weighted basis, and Goldman Sachs believes that the US dollar's depreciation journey is not yet over.

On Thursday, Jan Hatzius, Chief Economist of Goldman Sachs, said that there is still room for the US dollar to decline further in the future. The increasing pressure on global investors to adjust the US dollar assets in their portfolios will exert downward pressure on the US dollar.

Looking further, Hatzius pointed out that the challenging outlook for US economic growth will also reduce the interest of non-US investors in US assets, thus accelerating the depreciation of the US dollar. As for whether the US will enter a recession, the most crucial factor is tariffs. As long as the tariff war continues, a recession is inevitable.

Data from the Federal Reserve shows that the real value of the US dollar is still far above the average level during the era of the floating exchange rate system (starting from 1973). The current valuation level is similar to the situations in the mid-1980s and the early 2000s, and both of these periods laid the foundation for a 25%-30% depreciation of the US dollar.

Under the pressure of portfolio adjustment and current account deficit, the US dollar may be further sold off.

Hatzius pointed out:

On the one hand, due to the excellent performance of the US stock market in the past few years and the continuous inflow of overseas funds, the value of the US dollar has been pushed up, resulting in an excessively high proportion of US assets held by foreign investors in their portfolios. Once these investors start to reduce their holdings, the pressure on the depreciation of the US dollar will increase significantly. The International Monetary Fund (IMF) estimates that non-US investors currently hold $22 trillion in US assets, accounting for about one-third of the total value of their portfolios, and half of them are stocks without currency hedging.

On the other hand, due to the constraints of the balance of payments, the US current account deficit of $1.1 trillion needs to be financed by a net capital inflow of $1.1 trillion per year. If foreign investors' interest in purchasing US assets weakens, then either the prices of US assets will fall, or the US dollar will depreciate, or both, in order to achieve a balance of payments.

Looking further, the challenging outlook for US economic growth may also accelerate the depreciation of the US dollar:

It seems unlikely that the US economy will continue to outperform other countries in at least the next few years. Goldman Sachs recently lowered the growth forecasts of all major economies due to tariffs, and the downward adjustment for the US was the largest. The growth expectation of US GDP has also been lowered from 1% to 0.5%.

Considering the stagnation of GDP and corporate profit growth, the significant increase in the indicator of US policy uncertainty, and the doubts about the independence of the Federal Reserve, it is expected that the interest of non-US investors in US assets will weaken, thus accelerating the depreciation of the US dollar.

What are the economic consequences of the depreciation of the US dollar?

So, what are the economic consequences of the weakening of the US dollar?

Inflation pressure: The depreciation of the US dollar will intensify the upward pressure on consumer prices related to tariffs. Tariffs themselves may push the core inflation rate from the current 2.75% to 3.5% later this year, and the depreciation of the US dollar may increase it by about another 0.25 percentage points. This indicates that the "impact" of the increase in US tariffs will mainly fall on US consumers rather than foreign producers.

Narrowing of the trade deficit: The weakening of the US dollar will not only increase the prices of imports and consumer goods but also lower the prices of exports (measured in local currency). In the medium to long term, such changes in relative prices should help narrow the US trade deficit, which is also one of the goals of the Trump administration. Therefore, even without any form of the "Mar-a-Lago Agreement", it is unlikely that US policymakers will prevent the depreciation of the US dollar.

Financial environment and economic recession: Theoretically, the weakening of the US dollar can ease the financial environment and help the US avoid a recession. However, the driving factors of the depreciation are crucial. The decrease in demand for US assets, including US Treasury bonds, may offset the impact of the weakening currency on the financial environment. Looking further, the most important determinant of whether the US will fall into a recession is not the US dollar but the implementation of additional "reciprocal" tariffs or more aggressive tariffs on specific goods. If these factors continue to deteriorate, regardless of the trend of the US dollar, it may make a recession in the US inevitable.

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