Trump’s destructive US dollar desires

January 20, 2017


“Our companies can’t compete (with China) now because our currency is too strong. And it’s killing us,” Trump said. He went on to say that the US might need to “get the dollar down” if changes in taxation policy drove it higher.

“Having a strong dollar has certain advantages but it has a lot of disadvantages,” he said. His comments sparked a sell-off in the dollar…

There is also the possibility that the new administration will implement the “border tax” plan espoused by senior Republicans which would, in crude terms, tax goods bought outside the US while not taxing US exports.

While Trump appears to be cool on the idea, saying it is too complex, there is a consensus that if such a tax were implemented it would result in a very significant rise in the value of the US dollar.

While a strong US dollar does impact the competitiveness of US exports — and makes imports from China and Europe cheaper and more competitive in the US market — it also attracts inflows of capital.

With the US running a federal budget deficit of $US 587 billion last financial year, a forecast $US441bn deficit this year, US national debt nearing $US 20 trillion and Trump’s policies implying a further big increase in deficits and debt, the US needs capital inflows.

Whether the rhetoric around the value of the dollar matters is an open question. Despite the strong dollar policy there have been periods of US dollar weakness.

In reality, if Trump wanted to try to depress the value of the dollar against the currencies of the country’s major trading partners while pursuing its policy agenda, he would have to get control of the Fed and prevent it from raising US rates as it envisages — and prevent it from responding to an acceleration of US inflation that may flow from his tax cuts, infrastructure spending and deregulation.

That opportunity will be available towards the middle of his term, given scheduled retirements from the Fed’s board, but if it were seized it would destroy the credibility of the Fed and US monetary policy and, while it might see a flood of capital away from the US — and a lower dollar — it would be very destabilising.

Apart from jawboning, or the hijacking of the Fed, there isn’t that much the new administration can do to control the value of its currency. It was possible in 1985, when the “G-5” — the US, UK, West Germany, France and Japan — met at the Plaza Hotel in New York and agreed to take co-ordinated action, deploying their foreign currency reserves to force a devaluation and reduce a burgeoning US trade deficit that was generating growing trade tensions and imbalances. The “Plaza Accord” led to a major realignment of currency values and laid the foundations for Japan’s decades of economic winter.

A managed devaluation of the US dollar today would, given the divergence of monetary policies, be more difficult to execute. In the 1980s the G-5 had central bank foreign exchange and gold reserves of around $US 140bn and daily turnover in foreign exchange markets was about $US 40bn. Today, if the reserves of the core economies in the OECD were aggregated, they’d have about $US 7 trillion between them. Daily FX turnover now is about $US 6.5 trillion and US dollar daily turnover is about $U S4.5 trillion.

The markets have more firepower than central banks. That makes a strong dollar policy, or a weaker dollar policy, less relevant than it was in the 1980s. The markets will have the biggest influence over the value of the greenback and, given the economic and political state of Europe, the continued anaemic condition of Japan, the perceived financial vulnerabilities in China and the likely impact of Trump’s trade policies on China there aren’t many obvious “safe haven” currencies to choose from, let alone a currency likely to strengthen further if the Fed continues to raise rates.

A strong dollar — particularly if it were to strengthen further — could have some unintended destabilising consequences outside the US. While, in the absence of the protectionist policies Trump has foreshadowed, it would improve the competitiveness of European and Asian (and Australian) exports, the post-crisis era of ultra-low interest rates and dollar liquidity has seen developing economies’ US dollar-denominated corporate borrowings soar to an estimated $US4.5 trillion.

A surge in the dollar could therefore spark financial crises and recessions in developing economies, although, if it reflects stronger growth in the US economy, that would be broadly good for global growth.

It’s already apparent, as Trump takes office, that the near-term outlook for the US dollar is, whatever its longer-term trend, for volatility until the new president and his appointees can settle in, Trump’s actual policies are more detailed and understood, and he and his team are on the same page when they talk about the dollar and those things that influence its value.




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