The trade war rhetoric may result in the dollar weakening to address Trump’s focus on bilateral trade deficits and there is talk about the US Treasury intervening in currency markets for the first time since 1985.
Whatever you may think of Trump’s integrity, style, smarts or looks, there is no doubt that he has brought a cat amongst the pigeons on trade. And, given that the US is the largest buyer of goods from everywhere, his approach, like that of large buyers in any industry, is certainly sound. Give me what I want or else…
Of course, his pathetic “Art of the Deal” approach, where you begin with outrageous demands to ultimately get an acceptable deal, unsurprisingly, isn’t cutting any ice in global geopolitics where poker is eaten before breakfast. Nonetheless, Germany, in particular, has quietened down, since it cannot afford to have its car sales to the US threatened.
Other trading partners, too, are quietly working out compromises, with the exception of Turkey, where Erdogan is presiding over a pride-and-foolishness-driven collapse of the economy, and, of course, China. China is playing the same blusterous game as Trump, although, ever pragmatic, behind the scenes, many Chinese manufacturers are cutting prices and, late on Friday, the yuan surprised markets by suddenly shooting higher against the USD.
Indeed, rather than a currency war, where countries competitively devalue their currencies to retain traction on trade, the trade war rhetoric may result in the USD weakening across the board to address Trump’s pointed focus on bilateral trade deficits. There is already talk about the US Treasury beginning to intervene in currency markets to weaken the USD; if this were to happen, it would be the first time in over thirty years (since the Plaza Accord, 1985).
At that time, the move was driven by American companies who felt they were becoming uncompetitive relative to Europe and Japan; importantly, the intervention was coordinated between the central banks of all the countries involved. It was partly successful in that the trade deficit with Western Europe declined by over 50%, although it had little impact on the deficit with Japan, which was a much more regulated economy at the time—no prizes for guessing who plays that role today.
This time the story is different because the push is coming from the president, rather than the corporate sector, which has done very well, thank you, by globalisation, and is, generally, against any kind of trade war since it would disrupt supply chains, increase prices at home and, likely, squeeze profits. The president, never confused with being a deep thinker, doesn’t understand that the reason so many people in the US have not shared in the fruits of the huge boom over the past two decades is not globalised trade (which has increased the size of the cake) but venal domestic tax policies (that continue to divide the cake unequally). Again, he clearly doesn’t understand that the trade deficit is simply the difference between what Americans (including the federal government) save and spend. His budget deficit-inflating tax cuts will keep the trade deficit high irrespective of what happens to the USD.
And yet again, he doesn’t understand that interfering with the Fed’s independence ultimately weakens the economy. The last time the Fed came under political pressure—and then, too, it was triggered by protests from American companies—was in the early 1980’s, when Paul Volcker pushed rates up to nearly 20% to tame recalcitrant inflation. While inflation appears well under control today, the truth is inflation never dies and investors know that an independent Fed is the only real security against this beast. Nonetheless, markets respond to the loudest stimulus, which may explain why, despite the fact that the Fed has made it clear that—Trump or no Trump—US rates are certainly going to climb this year, the USD has been unable to move much above a DXY level of 95. For context, over the last ten years, the DXY has moved between 73 and 103, so it is already much closer to its high than its low.
So, is the USD going to turn down, bowing to Trump’s wishes? Nobody, least of all Trump, really knows. Indeed, even if the turmoil in his administration and personal circle intensifies, it is impossible to judge what will happen to the USD. Will it strengthen on its usual safe haven status? Or will it weaken as the political circus renders the US’ safe haven status less safe?
And, what will be the impact on the INR, which has, in the last week, blasted—twice—through the 70 to the USD barrier, and twice returned below it? Deteriorating trade numbers and global macros (and hundreds of knee-jerk analysts) argue for further INR weakness. On the other hand, over the past ten years, USD/INR has had an 81% correlation with DXY, so if the USD does turn lower globally, the INR could steady into a range of, say, 67 to 72.
The author is CEO of Mecklai Financial