President Trump’s almighty dollar

It is no secret that President Trump is very unhappy about the U.S. dollar’s strength. Whether there is much that he will do about it is quite another matter. Indeed, there is every reason to believe that in the year ahead we will see a further meaningful appreciation in the dollar’s value. This will occur despite Trump’s expected further attempts to jawbone it lower.

The dollar’s anticipated appreciation next year will not be so much the result of the intrinsic strength of the U.S. economy. Rather, it will be the result of the relative weakness in the rest of the global economy as well as of the dollar’s appeal to investors as a safe haven in times of unsettled international financial markets.

Another way of putting this idea might be that the U.S. dollar is likely to remain the tallest dwarf in the room.

One of the president’s principal campaign promises was to eliminate the U.S. trade deficit and to level the international trade playing field. It is against that background that he has kept bemoaning the dollar’s persistent strength and that he kept accusing the European Central Bank and the Chinese authorities of engaging in currency manipulation.

Yet despite these exhortations, the dollar has shown little sign of weakening. Indeed, since Trump assumed office at the beginning of 2017, the dollar has appreciated by almost 10 percent. That has taken its overall appreciation since the beginning of 2014 to around 30 percent.

The dollar’s continued strength should have come as no surprise to  Trump, especially considering how much his policies have contributed to that strength.

By engaging in a large deficit-busting tax cut in 2017 at a time when the U.S. economy was at close to full employment, Trump contributed to the widening 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 a number of fronts, he contributed to a greater economic slowdown in the rest of the world’s relatively open economy than has been the case in the relatively closed U.S. economy. This too has led to a situation in which foreign interest rates were forced lower relative to U.S. interest rates.

Looking ahead, it is all too likely that the rest of the world’s economy will continue to weaken relative to that of the United States. That in turn will keep U.S. interest rates at more attractive levels than those abroad, which will further buoy the dollar.

The world economic outlook certainly gives cause for concern. At a time when the European economy is already on the cusp of an economic recession and Brexit uncertainty casts a shadow over its economy, Germany continues to be reluctant to use fiscal policy to stimulate its weakening economy.

Meanwhile, largely as a result of the trade war and the deflation of its credit bubble, the Chinese economy is registering its lowest economic growth rate in nearly three decades. For its part, Latin America’s economy is beset by economic policy uncertainty in Brazil and Mexico and by political uncertainty in Argentina, Bolivia, Chile and Venezuela.

Next year, in the event that the world economy succumbs to recession, the dollar could be propelled significantly higher. With the world drowning in debt and with credit risk grossly underpriced, there is the serious risk that a global recession could cause serious dislocation in the world’s financial markets as credit markets reprice risk. Were that to occur, one would expect that money from around the world would once again seek the safe haven of U.S. Treasury bonds and provide strong support to the dollar.

A strong dollar and a weakening global economy certainly do not bode well for President Trump nearly fulfilling his campaign promise to reduce the country’s trade deficit. Since assuming office in early 2017, far from narrowing, the U.S. trade deficit has already widened by some 40 percent.

One can only hope that a further widening of the trade deficit will bring home to the president the futility of engaging in trade wars to reduce the trade deficit. Maybe that will focus his mind on the need to rein in the ballooning U.S. budget deficit, which is the proximate cause of our widening trade 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.