Could DeepSeek Dethrone the U.S. Dollar?

Deepseek app logo on a modern background of Wall Street and the US flag

05 February 2025 – Last week, DeepSeek, a China-made artificial intelligence (AI) model shook the tech world, bringing a new AI chatbot to market at a fraction of the price of other key global players.

As markets continue to gauge the technological impact, as well as its asset price implications, a key question emerges – could China’s technological breakthrough challenge American exceptionalism – the outperformance of US risk assets and the US dollar relative to global markets? This  is a scenario that merits consideration.

In recent years, American exceptionalism in financial markets has been underpinned by three pillars.

  1. Expansionary government policy: The US is running record deficits at a time when its economy is growing above potential. The acceleration of fiscal stimulus can be traced back to President Biden’s economic policy and has supported real growth in the US relative to the rest of the world. This has been aided by the use of migration policy as an economic lever, with net international migration in the US rising by over 7 million people cumulatively between 2020 and 2024.
  2. US technological leadership: The US has dominated in technological innovation, particularly in AI. Many of the early-stage beneficiaries of this have been seen as exclusively US companies, a trend reflected in the strong performance of the “Mag 7”, which accounted for a third of the US equity market at the end of last year.
  3. Higher US interest rates. Higher interest rates have been a direct reflection of the US economy growing above trend with this growth underpinned by the aforementioned factors, which has driven investor confidence.

These three factors have in turn supported US dollar strength. Fiscal stimulus and immigration have driven domestic growth stronger relative to the rest of the world, making the US an attractive destination for investment. Meanwhile, AI development has generated substantial financial assets in the equity market, attracting interest from global investors. At the same time, higher interest rates have continued to pull capital in from overseas. As a result, the real effective exchange rate on the USD is now at cycle highs.

As the dollar has risen, global economic activity has been dampened. Many firms outside the US borrow and fund their supply chains in dollars, so when the dollar appreciates, their purchasing power and capacity to use it declines. This, in turn, dampens global production and manufacturing cycles, which then also exacerbates US economic outperformance (given that it is a relatively insular economy), causing the cycle to repeat.

This self-reinforcing market behaviour has been playing out over the last three years, and not for the first time. George Soros coined this as the dollar’s “imperial circle” in 1984, at a time when Reagan’s expansionary fiscal policy and high rates relative to other major economies drove similar market outcomes.

What breaks the dollar’s imperial circle?

In the 1980s, the dollar’s imperial circle was ultimately broken by the initiation of the Plaza Accord, where the world’s major economies agreed to unilaterally weaken the dollar in response to a threat of tariffs by the US government. This required not only widescale currency interventions, but also a commitment from economies (namely Japan and Germany) to pursue loose fiscal policies. As a result, the dollar depreciated by 25% in the two years that followed. However, the subsequent decline was halted by the Louvre accord in 1987, which aimed to stabilise the dollar.

Looking forward, several potential drivers could disrupt the dollar’s dominance. For example, it could be a ‘Plaza 2.0’ accord or a convergence where US growth slows due to fiscal tightening and declining immigration, while growth in China and Europe recovers, diminishing US growth outperformance and relative higher interest rates, . 

There is still the issue of US technological leadership, which remains a factor in maintaining the dollar strength. This is where DeepSeek comes in. The arrival of ChatGPT in November 2022 sparked a rally in asset prices and increased investment expectations in the energy, technology and industrials sectors, underpinning US economic strength. If DeepSeek’s efficiency gains are verified, it is likely to lead to lower investment requirements and a flattening of technology barriers at a global level. Both will implicitly benefit energy-poor regions and relative tech laggards, thereby undermining one pillar of US exceptionalism.

In a world that may be less amenable to a Plaza-like settlement, perhaps technology will prove the first spark. While history doesn’t repeat itself, it often rhymes.

About the Author

Alex Holroyd Jones, Multi Asset Portfolio Manager, examines how DeepSeek’s challenge to US technological dominance may disrupt global markets. 

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