Foreign Currency

Trump’s confused approach to foreign exchange is back


News reports indicate that Team Donald Trump, given the opportunity for a second administration, believes it should ‘devalue’ the dollar and penalise those wishing to shift out of it. The approach to foreign exchange policy in Trump’s first administration was bad. But it appears the team didn’t learn its lessons and now wants to double down on the past.

This is aside from the fact that the dollar can’t be devalued, as it was in 1971 and 1973, since it isn’t officially set but floats.

What could Team Trump do to ‘depreciate’ the dollar? Trump’s first administration was a time of dollar strength, especially in 2018-19, though the dollar fell following rapid post-pandemic rate cuts and stabilisation (Figure 1).

Figure 1. The dollar was mostly strong under Trump

Source: Board of Governors of the Federal Reserve System

 

This was largely attributable to a macro policy mix conducive to dollar appreciation. Wider deficits due to tax cuts and reduced Federal Reserve accommodation put upward pressure on US yields. It was a similar policy mix to the pre-Plaza Accord period, though nowhere near as imbalanced. Additionally, Trump’s China tariffs were perceived as making foreign exports less competitive and increasing risk-off sentiment, reinforcing dollar appreciation.

A second Trump administration macroeconomic policy mix might be biased towards dollar strength. Team Trump will most likely make the case for tax cuts, raising the US deficit beyond its already excessive levels, adding to upward rate pressures.

If a second Trump administration has its way, it might pressure the Fed to cut interest rates, helping lower the dollar. But the Fed is independent, guided by its dual mandate and, consistent with longstanding G7 agreement, it backs market-determined exchange rates, pursues domestic objectives and doesn’t target the exchange rate. Even with a new Fed chair, the Federal Open Market Committee would be guided by data and hardly bow to administration diktats.

The current super-charged dollar, due to big budget deficits, high rates and risk aversion, may fall on its own if growth and inflation slow. Regardless, pursuing fiscal consolidation, cooling demand, reducing inflation and avoiding measures which exacerbate a risk-off environment would best achieve dollar softening. That does not seem to be Trump’s policy course.

What might lower the dollar?

Apart from sensible macroeconomic policies, how could another Trump administration lower the dollar? Unilateral or internationally coordinated foreign exchange market intervention might be one – though doubtful – avenue.

The first tool would be talking the dollar down. Putting to the side its wisdom, this approach would stir up global financial market volatility and is unlikely to have lasting impact.

The US could intervene alone. Whether major currency intervention effectively works is hotly debated. But on its face, the Treasury has few dollars it could sell to buy foreign exchange. The Fed can print unlimited dollars, but it would be highly unlikely to go along.

The US might cajole the G7 into expressing concern that foreign exchange rates were out of line with underlying fundamentals, but that alone would have a muted impact.

A Plaza Accord-type effort would entail coordinated G7 interventions and policy commitments for lowering the dollar. No administration can make credible fiscal commitments given Congress’ budgetary (ir)responsibilities and the G7 has long committed to not targeting exchange rates.

Diminished capital inflow would decrease dollar demand. Capital controls or taxes might therefore be a possible answer. No Trump official has proposed such a thing, but capital controls could harm financing of US fiscal deficits and raise interest rates.

Some on Team Trump recently suggested that maintaining the dollar’s reserve status is so critical that those who might diversify should be penalised. Doing that, however, would fly in the face of the openness of US capital markets and the very foundations of the dollar’s reserve status – as would capital controls or taxes. Moreover, such a ban hardly seems enforceable.

Attitude towards China

Trump has already threatened a 10% across-the-board tariff and 60% tariffs on China. While higher tariffs might lower the US trade deficit, they could prove inflationary,  lifting yields, aggravating risk-off sentiment and perhaps boosting the dollar.

The Trump presidency  rammed through an ill-conceived regulation on currency countervailing duties for ‘undervaluation’ attributable to ‘government action’ – i.e. intervention. There is no scientific way to measure equilibrium exchange rates. One country’s so-called ‘undervaluation’ may be the mirror image of and caused by an ‘overvalued’ dollar, attributable to America’s imbalanced policy mix. That is highly relevant today as the dollar is surging across the board. Further, foreign governments are selling dollars to support their currencies.

Trump used the Treasury foreign exchange report to designate countries for currency ‘manipulation’. In a fit of pique when the renminbi fell below 7.0 per dollar, Trump ordered the Treasury to designate China as a ‘manipulator’, even though China’s current account surplus was below the Treasury’s threshold for such a finding and China wasn’t intervening.

The Treasury later also designated Switzerland and Vietnam, though Switzerland – a small open economy with little debt – was conducting unsterilised open market operations via foreign exchange markets, while inflows to Vietnam were bolstered due to production processes moving out of China, which the Trump administration supported. The Trump designations proved feckless, gutting the credibility of manipulation findings.

Fiscal expansion at a time of whopping deficits, challenging  Fed independence, tariffs, possible threats to the dollar’s reserve currency status and confused foreign exchange policy thinking are the antithesis of enhancing America’s competitiveness and openness. Are America’s business leaders tongue-tied?

Mark Sobel is US Chair of OMFIF.



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