Why the US is whipping up a needless currency row with China, Japan and Europe
If any country is guilty of exploiting currency devaluation for their own ends, the US has been a prime exponent of the game for decades
Last week US President Donald Trump dipped into his policy primer on ‘How to lose friends and win enemies’ by fingering China, Japan and Germany as ‘global freeloaders’, implying unfair currency practices to gain advantage over America.
It’s ironic. If any country is guilty of exploiting currency devaluation for their own ends, America has been a prime exponent of the game for decades.
In times of crisis, it is a natural, knee-jerk reaction for policymakers to pull out all the stops to help their economy. So when 2008’s financial crash descended, the US authorities did a brilliant job pulling the economy back from the brink.
They slashed interest rates to zero, flooded the economy with lashings of QE cash, ramped up the budget deficit and debased the US currency with mass monetary expansion. It was an inspired piece of reflation thinking and it worked wonders for US domestic recovery.
Global investors instinctively took their cue from the US’s quadruple easing by marking the dollar down. And, over the next two years, bingo, US exports bounced back, American manufacturers had an extra helping hand and the US economy was propelled back into dynamic recovery. The deflated dollar was not an unforced error, but a deliberate plan of attack to put extra zing into the US economic revival.
It has been done before and it will be tried again. Past US presidents have never been shy about expressing their US dollar preferences. Unfortunately, it has pulled two ways and has often ended up fuelling nasty bouts of increased foreign exchange volatility in the process.
The 1985 G7 Plaza Accord was aimed at reining back the rampant ‘Superdollar’, heralded so much by Ronald Reagan during his presidency in the 1980s.
The G7’s cap succeeded so well, the dollar halved in value over the next two years, creating huge uncertainty for global investors, but a boon for US exporters.
And, when President George W Bush took up office in 2001, instructing the US Treasury to unpick President Bill Clinton’s favoured strong dollar policy, after complaints from beleaguered corporate America, the dollar lost a third of its value in the following two years. Yet, again, it was more relief for US exporters.
Trump’s forex broadsides have a purpose. He is clearly concerned about the dollar’s recent loss of competitive edge, as it conflicts with his vision of putting ‘America First’, pricing US products back into global trade markets and returning jobs to the domestic economy.
Trump’s claims that China, Japan and Germany are running cheap currency policies, means the whispering campaign for a weaker dollar has begun in earnest, but begs the question, ‘will it work?’.
One of the golden rules of foreign exchange markets is what governments and policymakers want for their currencies they generally tend to get. But global forex markets are extremely complex, with most factors outside policymakers’ control. Trump could get his fingers burnt early on.
Currency markets are driven an amalgam of powerful economic, financial, and geo-political forces – often in conflicting cross-currents. Interest rate and bond yield differentials, relative growth performance, purchasing power valuations, credit events and trade and capital flows all go into the algorithm for exchange rate determination. Too many of these factors remain overwhelmingly dollar-bullish right now.
Dollar bulls remain pumped up on US interest rates and bond yields offering hefty premiums over many major currency peers, especially the euro and Japanese yen. US growth prospects continue to outshine on many flanks. And while the US trade deficit still blows a black hole in the current account, America remains a compelling magnet for global investment funds, M&A activity and foreign direct investment.
The dollar’s safe haven appeal remains a powerful draw, especially in a world dominated by event risk and acute political uncertainty. In the next few months, the euro will be courting disaster again, as Grexit fears re-surface over another impending Greek debt crisis and the chances of France leaving the single currency after May’s presidential elections. If so, the US dollar becomes an investor bolt hole again.
And, while Trump and the US Treasury clearly hold the whip hand for forcing through a weaker dollar bias, forex markets are pretty savvy and will spot any cracks in the strategy, not least if a weaker dollar gets in the way of the Federal Reserve’s anti-inflation strategy.
One thing is certain. Trump’s interference in currency manoeuvring guarantees a roller-coaster ride for financial markets in the coming months.
David Brown is chief executive of New View Economics