One can understand President Trump’s frustration with the strong U.S. dollar. Having risen by almost 10 percent over the past year, the strong dollar has likely done as much to undermine U.S. international competitiveness as the president’s “America First” trade policy has done to improve our competitiveness.
It has also contributed to a widening of the U.S. trade deficit to its highest level in the past 10 years.
{mosads}However, the president is mistaken to scapegoat Federal Reserve Chairman Jerome Powell for the dollar’s rise as he is now again starting to do. Rather, he should seek to understand how his administration’s policies might have contributed to the dollar’s strength.
Maybe then there will be a chance for a change in policy that might spare the U.S. economy from undue dollar strength through the remainder of this year.
In a world of floating exchange rates, the value of a country’s currency is largely determined by the relative strength of its economy and by how restrictive its monetary policy is in relation to that of its main trade partners.
If the United States economy is strengthening and is raising interest rates at the same time that the European economy remains weak and is being forced to keep interest rates low, one must expect that the dollar will appreciate against the euro.
That is precisely what occurred last year as the U.S. economy generally outperformed those of the rest of the world. As the U.S. economy gained momentum and as it achieved full employment, the Federal Reserve was forced to raise interest rates in order to keep the economy from overheating.
This occurred at the same time that the European and Japanese economic recoveries began losing steam. That forced the European Central Bank and the Bank of Japan to push back the date at which they thought they would be in a position to start raising interest rates from their present zero lower bound.
In blaming Jerome Powell for high interest rates and a strong dollar, President Trump chooses to overlook his administration’s role in this state of affairs.
By choosing in 2017 to stimulate the U.S. economy with a very large unfunded tax cut at a time that it was at full employment, the president raised the real risk of having the U.S. economy overheat. This left Jerome Powell with little option but to tighten U.S. monetary policy to avert the risk that inflation again might raise its ugly head.
If the president were serious about wanting lower U.S. interest rates and a weaker dollar, he would revisit U.S. budgetary policy and take budget measures to reduce the burden that large budget deficits are now placing on the Federal Reserve to keep inflation in check.
With a more restrictive budget policy, the Federal Reserve would have the room to responsibly cut interest rates and to stop reducing the size of its balance sheet. That in turn would put downward pressure on the U.S. dollar.
The Trump administration’s America First trade policy has been a second way in which the president’s policies have contributed to dollar strength.
President Trump’s imposition of punitive import tariffs, with the threat of more to come, has done much to undermine investor and household economic confidence across Europe and Asia. That in turn has led to a more dovish monetary policy stance in those economies in relation to that pursued in the United States.
The easing of U.S. trade tensions with China would seem to be a step in the right direction of restoring economic confidence abroad.
However, there is now the serious risk that, with European and Japanese automobile having been determined by the U.S. Commerce Department as a national security threat, within the next 90 days the president will follow through on his threat to impose a 25-percent automobile import tariff.
If that were to happen, the already faltering European and Japanese economies would be dealt a severe body blow that would propel the dollar higher.
I am not holding my breath for a substantive change in President Trump’s economic policy given how much easier it is for President Trump to blame Jerome Powell for high interest rates and a strong U.S. dollar than it is for him to change U.S. budget and trade policy.
Rather, I am bracing myself for more dollar strength and more Federal Reserve bashing as the 2020 election campaign gathers steam.
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.