Can Trump weaken dollar?
By Kim Hyeongwoo
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President Trump often suggests in media interviews that our currency is too strong and it is killing us. Reflecting this view, the dollar has depreciated by 1.92 percent against major currencies since December 2016. However, the dollar’s value is still more than 35 percent higher than in April 2011. Will Trump employ his so-called weak dollar policy? If he does, can he succeed?
Since his inauguration, Trump has announced an array of “America first” economic policies. He expressed his intention to renegotiate the North American Free Trade Agreement (NAFTA), blaming it for the loss of manufacturing jobs in the Rust Belt. He also threatened companies with high border taxes to prevent production shifting to other countries like Mexico. In addition, he abandoned the Trans-Pacific Partnership (TPP), claiming it would harm American workers. That is, Mr. Trump made it clear that he would pursue protectionist trade policies. However, a strong dollar could still be a problem in bringing back manufacturing jobs in the U.S. because it will make U.S. products more expensive for foreigners.
It is time for a fact check. Is the dollar really too strong ― meaning is it over-priced? I am skeptical. Recent appreciation of the dollar has been driven mainly by a stronger U.S. economy. The Federal Reserve (Fed) has already raised interest rates twice and is contemplating another hike after ending the Zero Interest Rate Policy (ZIRP) that had been in place from December 2008 to December 2015.
On the other hand, the European Central Bank (ECB), Japan, and Switzerland are still struggling with either zero or even negative interest rates. That is, stronger economies are accompanied by stronger currencies because (real) interest rates are higher, providing greater returns on those currencies. Therefore, the dollar does not seem to be over-priced.
If that is the case, how can Mr. Trump weaken the dollar?
One may suggest a dramatic policy initiative like the Plaza Accord in September 1985. That is, major countries may work together for a dollar depreciation against other currencies in the foreign exchange market via international policy coordination. As Carmen Reinhart at Harvard recently discussed, however, this scenario is not likely to be realized because other countries do not have room for such coordination.
Germany’s economy seems to be strong enough to withstand dollar depreciations, but it is part of the Eurozone and its central bank, the ECB, would not agree with such policy coordination because it requires the sacrifices of other Eurozone member countries that are in economic distress.
What about China? I am dubious. China's foreign exchange reserves fell from $3.99 trillion in June 2014 to $2.99 trillion in January 2017, even though government authorities recently tried to curb capital outflows by tightening capital controls. Depreciation of the dollar required China to sell (lose) dollars, which will result in a further drain of its foreign exchange reserves. Therefore, China probably would not consider such a policy initiative.
If that is not feasible, can the Trump administration put pressure on the Fed to lower the target Federal Funds Rate (FFR)? A lower interest rate helps weaken the value of the U.S. dollar by making dollar denominated assets less attractive. This possibility, however, is against the normalization plan of Fed Chairwoman Janet Yellen. As is well-known, the Fed is quite independent of political pressures, so it is hard to imagine that this scenario would come to a realization, maybe at least until January 2018 when her term ends.
It is possible that Trump might nominate a successor who shares the same philosophy as himself, but it might be very difficult for the candidate to be confirmed by the Senate even though Senate Republicans hold slim majority, as we have seen in the case of Betsy DeVos who was confirmed with the help of a historic tiebreaking vote from Vice President Pence.
Furthermore, Trump’s weak dollar policy is inconsistent with his proposed expansionary fiscal policies. Lowering taxes and increasing government spending on social infrastructure naturally results in budget deficits. If raising taxes is not an option, the government has to finance expansion t by issuing more Treasury Bonds, which then results in higher market interest rate. As we have seen before, higher domestic interest rates strengthen the dollar, contradicting a weak dollar policy.
So it seems that Mr. Trump will have to deal with many obstacles if he attempts to weaken the dollar to gain U.S. manufacturing competitiveness. Of course, the dollar will depreciate against other currencies if the U.S. goes into a long period of recession while other countries are booming. A global recession would do the opposite, triggering risk aversion and strengthening the U.S. dollar. I doubt Mr. Trump would like that strategy.
Dr. Kim Hyeongwoo is an economics professor at Auburn University. He received his Ph.D. from the Ohio State University, and his B.A. and M.A. from Seoul National University. He published over 25 SSCI journal articles since 2009 in the areas of macroeconomics, financial economics, and economic forecasting. He can be reached at gmmkim@gmail.com.