The U.S. dollar hit a 14-year high at the beginning of the year before pulling back, after Donald Trump declared that the strength of the greenback was “killing us.”
Over the past 24 months, the U.S. dollar has appreciated 14 percent against the euro and the Canadian dollar, 26 percent against the British pound and 47 percent against the Mexican peso, and fallen four percent against the Japanese yen.
A currency’s strength is driven by several economic factors, principally the growth rate of the economy, interest rates, inflation levels, and trade and capital flows.
As well, emotional elements – fear, greed, optimism, the perception of a country’s economic prospects, and political stability or lack thereof – can, in the short-term, override more tangible economic considerations.
The U.S. economic recovery since the 2008 recession has been among the weakest on record. The recent strength of the dollar owes more to the relative weakness of the rest of the world’s economies than to the strength of the American economy.
Japan is mired in very low growth, while a declining population reduces demand in many key sectors.
The European Union is dealing with a host of problems, from the never-ending Greek debt crisis to a banking crisis in Italy, particularly weak economies along its Mediterranean fringe, the rise of right-wing Euro-skeptic parties, a rise in nationalism and growing dissatisfaction with the EU’s bureaucratization and centralization, the impact of the British decision to leave the association, the rise of jihadist-inspired terrorism and the problems of integrating around one million Syrian refugees.
Weakness in commodity markets, especially petroleum, has impacted the currency of a host of nations, both industrialized commodity producers like Canada and Australia, and the previously rapidly-growing BRICs (Brazil, Russia, India and China). Weakness in China, in particular, has had a major impact on commodity exporters. Mexico has been impacted, by declining energy and commodity prices, and by political concerns that President Trump’s administration will act to reduce the flow of Mexican exports to the U.S.
Many of the economic policies proposed by the Trump administration, such as a decrease in government regulation, lower corporate taxes and energy independence, are bullish for the dollar. None of this is new, of course. Currency traders are quick to point out that the U.S. dollar is being massively overbought by speculators and that, notwithstanding American prospects, in the short-term the U.S. dollar is more likely to pull back before it continues to rise.
Central banks typically lower interest rates when they look to weaken their currencies and do the opposite when they’re trying to defend exchange rates. Given the historically low levels of interest, lowering U.S. rates will not be a viable way of curtailing the dollar rise. In fact Janet Yellen, the chairwoman of the Federal Reserve, has consistently stated her intent to slowly but steadily increase U.S. interest rates.
If the Trump administration successfully implements its economic agenda and the rest of the world continue on their lacklustre economic track, the very success of the new administration’s economic policies will continue to push the dollar higher.
Long term, a rising dollar is good for U.S. financial markets, and for keeping inflation and interest rates low. But it makes it harder to jump-start the American manufacturing sector.
There’s also a larger concern that aggressive efforts to devalue the exchange rate of the U.S. dollar, combined with nationalistic trade policies and import tariffs, could upend the international financial system. The U.S. current accounts deficit is an important source of dollars, and hence financial liquidity, to the rest of the international economic system. Any contraction in that flow of dollars as a result of lower imports or higher foreign investment in the U.S. will reduce the dollars in global circulation.
A significant portion of the world’s corporate and sovereign debt is in U.S. dollars. Policies that diminish the worldwide supply of dollars will push up the dollar’s exchange rate. An all-out trade war would spike the dollar in the short term, disrupting and possibly damaging the international monetary system and corresponding trade flows.
In the short term, there’s little Trump can do to talk down the dollar. A strong dollar will be a direct result of successfully implementing his policies even if dollar strength will make his goal of revitalizing American manufacturing that much more difficult.
A weak dollar will be the surest sign that the Trump administration’s economic policies have gone awry –and that spells trouble for the U.S. and the rest of the world.
Joseph Micallef is an historian, best-selling author and, at times, sardonic commentator on world politics.
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