Mars And Mercury Decide The Fate Of The U.S. Dollar And Gold

The U.S. dollar has been bleeding recently, despite all the Fed’s tightening efforts and the passage of Trump’s tax cuts. An accelerating economy, rising interest rates, and pro-growth reforms should logically drive the value of the American currency. But they didn’t.

Given the strong negative correlation between the greenback and gold, finding the cause behind the dollar’s wounds is highly critical. The most common explanation among analysts is Trump the Destroyer. It shouldn’t be surprising, as the U.S. President is known for his passion for trade protectionism. He also explicitly favors the weak currency to help the exporters. So maybe Trump just got what he wanted?

It definitely may be part of story, but there is one catch. Trump’s economic policy hasn’t been as bad as expected. The costs of the tax cuts would be smaller than those resulting from his campaign promises. And the trade policy turned out to be more moderate with respect to Trump’s worst ideas – such as broad tariffs on Chinese or Mexican imposts – which were abandoned, or at least frozen (but in January 2018, the President managed to introduce steep tariffs on imported washing machines and solar panels).

However, the administration’s isolationist and capricious foreign policy is a different kettle of fish. Investors should remember that there are two sides of a reserve currency’s international appeal. One of them is economic (safety, liquidity, yield, economic relations), but the second – which is also important – is geopolitical (diplomatic and military power). Referring to Roman mythology, we could say that two gods determine the dollar’s value: Mercury and Mars. The former was the god of commerce, while the latter the god of war.

In 2017 paper, Barry Eichengreen of the University of California, Berkeley, and Arnaud Mehl and Livia Chitu of the European Central Bank tested both – Mercury and Mars – hypotheses. The scholars found an important geopolitical or security premium in international currency choice. According to their estimates, military alliances boost the share of the currencies of alliance partners in foreign reserve portfolios by close to 30 percentage points.