“I think our dollar is getting too strong,” said President Donald Trump three months ago, “and partially that’s my fault because people have confidence in me. But that’s hurting — that will hurt ultimately.”
If the problem was excessive confidence in the president, it appears to have been solved. This week the dollar, on a trade-weighted basis, dropped to levels at which it last traded in June last year, before the Brexit referendum forced a one-off revaluation of the dollar against the pound.
In January, the dollar index was trading at a 14-year high and then President-elect Trump was worrying that: “Our companies can’t compete with them [Chinese companies] now because our currency is too strong. And it’s killing us.” Anthony Scaramucci, then close to the administration and a week ago appointed its head of communications, said: “We have to be careful about the rising currency.”
Since then, the trade-weighted dollar has dropped 10 per cent. For an administration that came to power trumpeting its determination to put America first and to resort to protectionism if necessary, this is a success. A devaluation like that automatically makes imports more expensive and exports more competitive — it is as effective as a tariff.
But why exactly is the dollar weakening? Does it show success for the administration in talking the dollar down (apparently an aim). Or is it more about a loss of the confidence in Mr Trump that he was once blaming for the dollar’s strength? Or could it have little to do with Mr Trump, even if his exploits — and those of his henchmen, and of his party in Congress — dominate the media?
To defend the idea that this is all about Trump, note that the dollar rose sharply after last November’s election. The result was a surprise, as was the working majority for the Republicans in both houses of Congress. Uncertainty had been replaced with clarity. Trump-Republican policies of cutting taxes and spending on infrastructure would stimulate the economy and push up the dollar. Protectionist tariffs, if imposed, would be greeted with a rise in the currency to counteract them — so it was logical to push down almost all other currencies against the dollar after the election.
Since then, policy developments have been terrible for the dollar. There is nothing on infrastructure, no tariffs — and the failure to do anything about healthcare raises the once unimaginable risk that Republicans might not even be able to agree on a tax cut.
Political uncertainty is back. The inquiry into Russian interference in the election, and the president’s apparently desperate attempts to thwart it, have raised comparisons with Watergate. The dollar does badly during scandals — such as Watergate, and also the Iran-Contra scandal under Ronald Reagan. This and the bizarre news flowing out of the White House should hurt the dollar.
Against this, you could base an argument on fundamentals. Ignoring politics, the US economy seemed strong and ready to expand six months ago, while Europe’s appeared in the doldrums. Since then, US core inflation has fallen, and the eurozone has enjoyed a surprisingly strong recovery. The election of President Emmanuel Macron in France has given the eurozone a fillip of confidence. Investors’ money is pouring into Europe. Without looking at the Trump Twitter account, these developments would entail a falling dollar.
The problem with this is that the bond markets, which express economic fundamentals, suggest that the dollar should be strengthening this year. Over time, currencies tend to move according to yield differentials — higher interest rates in one country will draw funds there, and push up its currency. There are various ways to measure this but, if we compare two-year yields, the chart shows that the gap of US over German yields is as wide as it has been in more than a decade. The exchange rate usually follows the yield differential, so the dollar’s fall suggests something unusual is afoot — probably a loss of confidence in Mr Trump.
If this is so, then in the short term it looks as though any bet on the dollar is a bet on US internal politics, and hence in part on the temperament of Mr Trump. Few want to make such a bet. Success or failure of a tax cut could be a decisive moment, as might an escalation of the Russia scandal (such as an indictment).
In the longer term, economic fundamentals (probably affected by politics) will reassert themselves. To predict the strength of the dollar in a few years you need to answer questions about central banks. If the Federal Reserve starts reducing its balance sheet, as seems likely, while its counterparts in Europe and Japan do not, that will strengthen the dollar. The very weakness of the dollar deters other central banks from tightening now, which will tend to strengthen the dollar in the longer run.
You also need to ask about the economy. How strong is the eurozone recovery, really? A lot of hopes have been hung on it. But if the US continues to grow faster than the eurozone, as is very much possible, then we should expect a stronger dollar in the long run — despite the lack of confidence in President Trump.