By Desmond Lachman
It is no secret that President Donald Trump is displeased with the dollar’s strength. Whether there is much he will or can do about this is another matter. Indeed, regardless of what course of action he chooses, there is every reason to expect further appreciation in the year ahead.
Rather than as a result of the intrinsic strength of the US economic, the dollar’s anticipated appreciation is more likely to be caused by the relative weakness in the rest of the global economy. Moreover, the currency will continue to appeal to investors as a safe haven in times of unsettled international financial markets. Put another way, the dollar will remain the tallest dwarf in the room.
One of the president’s principal campaign promises was to eliminate the US trade deficit and level the international trade playing field. It is against this background that he persistently bemoans the dollar’s strength and accuses the European Central Bank and Chinese authorities of manipulating their currencies.
Yet despite these exhortations, the dollar has shown little sign of weakening. Since Trump assumed office, the dollar has appreciated by almost 10%. That has taken its overall appreciation since the beginning of 2014 to around 30%.
The currency’s continued strength should have come as no surprise to the president. By engaging in a large deficit-busting tax cut in 2017 at a time when the US economy was at close to full employment, Trump contributed to the divergence in monetary policy between the Federal Reserve and the world’s other major central banks. At the same time, by engaging in a trade war on multiple fronts, he abetted a greater slowdown in the rest of the world’s relatively open economy than has been the case in the relatively closed US economy. This led to a situation where foreign interest rates were forced lower relative to US ones.
The rest of the world’s economy will probably continue to weaken relative to the US. That in turn will keep US interest rates at more attractive levels than those abroad, which will further buoy the dollar.
The global economic outlook gives cause for concern. Europe is on the cusp of recession, and Germany remains reluctant to use fiscal policy to stimulate its weakening economy. China is registering its lowest growth rate in more than a decade. Latin America is beset by economic policy uncertainty in Brazil and Mexico and by political uncertainty in Argentina, Bolivia, Chile and Venezuela.
If the global economy were to succumb to recession, the dollar could be propelled significantly higher. With the world drowning in debt and with credit risk grossly underpriced, there is the risk that a recession could cause serious dislocation in the world’s financial markets as credit markets reprice risk. Were that to occur, money would seek the safe haven of US Treasury bonds and provide strong support to the dollar.
A weakening global economy and strong dollar will hamper mightily Trump’s chances of reducing the US trade deficit. In fact, since Trump entered the White House, the deficit has widened by around 40%. Further widening may clarify for the president the futility of his trade wars, and perhaps focus his mind on the need to reign in the ballooning US budget deficit.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.