Trump’s bad idea of dollar intervention

It has been said that bad economic ideas are like going to the greyhound races: If you stand in one place for long enough, the dogs will come around one more time.

So too it now seems with the mixed signals that President Trump is giving on the failed idea that it might be good for the United States to engage in dollar selling to weaken the dollar.

Never mind that many earlier episodes of dollar intervention did little more, at best, than change the dollar’s value for a very short time. Never mind, too, that since 1995 no U.S. administration has resorted to foreign exchange market intervention except briefly and in the most exceptional of circumstances.

One can very well understand Donald Trump’s frustration with a strong dollar. This is especially the case at a time that he is desperate to eliminate the U.S. trade deficit.

After all, since 2014 the dollar has appreciated by almost 30 percent, and it is continuing to appreciate this year. This has made U.S. exports much less competitive in international markets than they otherwise would be, while at the same time increasing the attractiveness of imports in the U.S. domestic market.

It is much more difficult to understand why the Trump administration seems to be thinking that foreign exchange market intervention would work today when it has failed so miserably on so many previous occasions. This would seem to be particularly the case when one considers how limited are the resources available to the administration for intervention in relation to the massive size of the foreign exchange market.

According to the Bank for International Settlements, the daily amount of foreign exchange traded is more than $5 trillion, making it the world’s largest financial market. This daily volume totally dwarfs the $75 billion that the U.S. has to sell from its dollar holdings in the Exchange Stabilization Fund. It would also dwarf the amount that would be available for intervention even if the Fed were to match the Exchange Stabilization Fund.

The truth is that the dollar’s value is mainly determined by fundamental economic factors. Principal among these is the stance of U.S. monetary policy relative to that of its main trade partners. If, for instance, the U.S. is tightening its monetary policy stance while Europe is loosening its monetary policy stance, one would expect that the U.S. dollar would appreciate against the Euro.

Viewed through this lens, one is forced to the conclusion that far from weakening the U.S. dollar as intended, the Trump administration’s policies are doing the exact opposite.

An expansive budget policy, underlined by the Trump tax cut and now by public spending increases associated with the debt ceiling deal, is forcing the Federal Reserve to hold U.S. interest rates at a higher level than otherwise would be the case. At the same time, by contributing to economic weakness abroad, Trump’s America first trade policy is forcing foreign central banks to loosen their monetary policy stance to provide stimulus to their weakening economies.

If the Trump administration were serious about wanting to weaken the dollar, it would not now be flirting with the failed dollar intervention policies of the past. Instead it would be focusing on mending its wayward budget ways in a manner that might leave the Federal Reserve more room to responsibly reduce interest rates. At the same time, it would be putting real pressure on countries like Germany, which has the budget room to do so, to loosen its purse strings and to take some of the burden of supporting the economy from their central banks.

Sadly, the Trump administration’s track record over the last two years gives one little reason to think that it has a deep understanding of international economics. Which is why I fear that it very well could decide to engage in dollar intervention and in the process lead the world down the path of a destructive trade and currency war.   

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.