How Will President Trump’s Tariffs Affect the Value of the Dollar?

President Trump has announced that new tariffs will go into effect on April 2, following several weeks of threats. These new tariffs are likely to be broader in scope than the limited ones implemented thus far. So who is likely to pay for them? A good first step is to divvy up the incidence of the tariffs between foreign producers and domestic consumers, much as economists would do for most taxes. But taxes on trade have some special implications that aren’t present for domestic taxes: namely, they can have an impact on the relative value of currencies, making the question of incidence more complicated.

Some Trump administration officials have taken note of this effect. Council of Economic Advisors Chair Stephen Miran discusses it considerably in a November 2024 policy paper. The topic also came up in the confirmation hearing of Treasury Secretary Scott Bessent.

A country that implements tariffs can indeed sometimes expect the value of its currency to increase. An IMF study of 151 countries between 1963 and 2014 showed that tariffTariffs are taxes imposed by one country on goods imported from another country. Tariffs are trade barriers that raise prices, reduce available quantities of goods and services for US businesses and consumers, and create an economic burden on foreign exporters. increases resulted in real exchange rate appreciation, but only mild impacts on trade balance.

This empirical result is what economic theory would predict, on average. But it is only sometimes true, not always. Here we will discuss why currency appreciation might matter, and what conditions might lead President Trump’s tariffs to cause currency appreciation.

The bottom line: while currency appreciation is a common impact of tariffs, the volatile nature of the regime might dampen the currency effect of tariffs, and other effects (such as the US becoming a less attractive place to invest) may dominate instead.

What are the stakes of currency appreciation?

Currency appreciation is neither a good thing nor a bad thing per se; it is beneficial to imports and detrimental to exports. For example, consider what happens to an import when the US dollar appreciates: it’s produced in foreign countries with weaker currencies, and consumed in the US with the strong currency. That effectively makes costs low, prices high, and profit easy to come by. Exports find the reverse: producing in the US means that costs are in the strong dollar, and exporting outside the US means that customers have only weak foreign currencies to offer.

The currency effect of a tariff (which helps imports somewhat) works against the more direct incidence of the tariff (which falls on imports.) All in all, the currency effect partially mitigates the tariff’s incidence on the importers. However, the incidence doesn’t disappear: instead, some of it is reallocated to exporters.

The currency effect also explains why tariffs are ineffective at changing trade balances: while the direct incidence of the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. would seem to encourage trade surpluses, currency appreciation encourages the reverse, and the effects can roughly offset. This would explain the limited trade balance reaction found in the IMF data.

Why might a tariff cause a currency to appreciate?

Economic theory posits that a US tariff causes the dollar to appreciate, or makes it harder on net and in the long run for foreigners to acquire dollars. Before discussing caveats, it’s first important to understand the mechanism.

Foreign exchange is usually an afterthought to the people buying and selling goods or services. The global banking system typically handles it ably and swiftly. But import and export activities each have a permanent impact on the foreign exchange market. US imports effectively permanently “convert” foreign currencies into dollars by generating expenses in foreign currency and revenues in dollars. A Korean television maker is effectively a machine for creating surpluses of US dollars and shortages of Korean won by exporting TVs to the US. Overall, the business model earns dollars from the US customer, but loses won when it pays Korean workers to make the product. The trade requires an exchange of dollars for won on the open market to address the difference in currency. By contrast, a US aircraft manufacturer that sells aircraft to Korean airlines has the inverse problem: Korean purchasers have won, but US aircraft builders want their wages in dollars. This requires an exchange of won for dollars to address the currency difference.

The firms may not engage in currency exchange directly (instead, for example, delegating the task to their banks or to customers’ banks) but they need it for their business model to work.

The foreign exchange market has many other participants. There are bond traders, there are companies rebalancing their reserves in the different currencies they do business in, there are market makers, there are savers rebalancing their investment portfolios. These trades make up the vast majority of foreign exchange transactions. But these trades come in on both sides of the market and largely cancel out. By contrast, importers or exporters consistently generate need for currency exchange in the same direction, quarter after quarter.

If market participants simply gave up entirely on importing products to the United States, on the grounds that they did not want to pay for tariffs, roughly a trillion dollars’ worth of dollar supply would vanish from global markets every quarter.

Tariffs create an anticipated scarcity of dollars—or at least, greater difficulty acquiring dollars—in expectation of imports falling and fewer dollars being exchanged for foreign currency. As a result, the theory goes, the dollar appreciates relative to other currencies. A stronger dollar, in turn, gives people a greater incentive to keep imports flowing, even through the tariffs, and explains why tariffs might have a more muted effect on trade balances.

Why might this effect fail to materialize for President Trump’s tariffs?

Why might the currency appreciation effect fail to materialize, or materialize only weakly? There are many reasons. The explanation above presumes a relatively consistent and steady tariff rate, one that effectively forms a barrier around the whole country. In order to get more dollars, on net, foreigners have to send goods through to US purchasers who pay tariffs. The higher price of the dollar reflects the difficulty of acquiring it.

However, if the tariff regime is less constant across time, across goods, or across countries, dollars may be easier to acquire than the tariff rate suggests.

• Import activities can shift across time to periods where tariffs are lowered or suspended. Some Trump administration tariffs end up proposed and then quickly suspended as the President reaches a deal with a foreign country. These should not have the trade-related foreign exchange impact described above, because trade can simply wait for the barriers to be lifted.
• Import activities can shift to goods facing lower US tariffs. If some particular industries (for example, imported alcohol) face especially high tariffs, businesses trading in goods with lower tariff rates can pick up the slack.
• Import activities can route through countries facing lower US tariffs. The Trump administration has often indicated that some countries will face higher tariffs than others. In the event that Colombia, Brazil, and Indonesia face different tariff rates on coffee, for example, trade will tend to lean towards the country or countries with lower tariff rates.

The substitutions described above are often costly or inconvenient, but they can somewhat mitigate foreigners’ difficulty in acquiring dollars under a tariff regime, limiting dollar appreciation.

In addition to the ways imports might try to route around tariffs, there are some other factors to consider:

• Foreign retaliation can offset currency appreciation by creating an effect in the opposite direction. When foreign countries retaliate (for example, the EU is likely to revisit retaliation in April) they create an offsetting drag on US exports that mirrors the drag on US imports created by the tariffs. If the retaliation is roughly equal to US tariffs, then no change in foreign exchange rates should be expected.
• Turbulence in capital markets might outweigh trade effects in determining exchange rates. In addition to imports and exports, another force with a strong impact on foreign exchange rates is the balance of saving and investment. The US is an attractive place to invest, and generally attracts global savings on net; that is, foreigners invest in the US more than Americans invest in the rest of the world. If the US is deemed a less attractive place to invest, the dollar may depreciate as foreigners look to reduce their investment in US assets. If markets are very unconfident in the US as a location for investment—for example, because they worry about cascading tariffs hitting intermediate goods—the capital markets effect could dominate the trade effect.

All in all, the fast-changing and ad-hoc nature of Trump administration policy thus far substantially reduces the power of the exchange rate mechanism described here. If a steady and consistent tariff regime emerges, though, the dollar is more likely to appreciate, which in turn will spread more of the incidence of the tariff regime to US exporters.

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