Trump will fail to increase exports with trade wars and tariffs. Currency wars will result.
Trade weighted dollar index data from the Fed. Chart by Mish. On a trade-weighted basis, the US dollar is the strongest since the early- to mid-1980s.That’s because the US has the strongest economy in the world and high interest rates to too.Tariffs will act to strengthen the US dollar. But to increase exports, Trump needs a weak dollar.Boatload of ContradictionsI have discussed this before, but Trump’s policies are a boatload of contradictions.Balancing the fiscal deficit would strengthen the dollar. Tariffs would strengthen the dollar and cause a rise in inflation.Bigger fiscal deficits would weaken the dollar aiding exports, but cause a rise in inflation.Is Trump a Free Marketer in Disguise?That’s the amusing October 14, claim made by Omkar Godbole on Yahoo!Finance Trump’s New Administration Would Support Strong Dollar
- A potential Trump administration is unlikely to devalue the dollar deliberately, Trump’s go-to man on economics Scott Bessent told Financial Times.
- Trump’s inflationary-imports tariffs plan will be eventually watered down, Bessent added.
[Mish Note: Since then, Trump nominated Bessent for US Treasury secretary.]
A new U.S. government potentially headed by Donald Trump would support a strong dollar in line with the U.S.’ multi-decade policy.
“The reserve currency can go up and down based on the market. I believe that if you have good economic policies, you’re naturally going to have a strong dollar,” Bessent added, cautioning he is not speaking for Trump.
Bessent also defended Trump’s intention to impose across-the-board inflationary tariffs of up to 20% on all imported goods, saying these “extreme positions” will be eventually watered down during discussions with trading partners.
“My general view is that at the end of the day, he’s a free trader,” Bessent told FT. “It’s escalate to de-escalate.”
ECB Governors Back More Rate cutsReuters reports ECB Governors Back More Rate Cuts if Inflation Settles at Goal
Four European Central Bank policymakers backed further interest rate cuts on Friday provided that inflation settles at the ECB’s 2% goal as expected.
The euro zone’s central bank cut interest rates for the fourth time this year on Thursday and kept the door open to more easing, although some analysts felt President Christine Lagarde’s signal in that direction was less clear than they had hoped for.
The ECB lowered the rate it pays on banks’ reserves by 25 basis points to 3.0% on Thursday and investors expect at least another 100 basis points worth of cuts by June.
Fed vs ECB Rate CutsIn isolation, rate cuts weaken currencies.In this case we have dueling cuts by the ECB, the Fed, and China. However, US growth is much stronger and inflation is higher. And China is in or near outright price deflation.The combined impact of the above is a stronger dollar, not at all synonymous with rising US exports.What About Currency Intervention?The lead chart notes two instances of currency intervention, the Plaza Accord and the Louvre Accord.The first was an agreement to weaken the US dollars and the second an agreement to strengthen the dollar.Both failed.Plaza Accord
The Plaza Accord was a joint agreement signed on September 22, 1985, at the Plaza Hotel in New York City, between France, West Germany, Japan, the United Kingdom, and the United States, to depreciate the U.S. dollar in relation to the French franc, the German Deutsche Mark, the Japanese yen and the British pound sterling by intervening in currency markets. The U.S. dollar depreciated significantly from the time of the agreement until it was replaced by the Louvre Accord in 1987. Some commentators believe the Plaza Accord contributed to the Japanese asset price bubble of the late 1980s.
Background
From 1980 to 1985, the dollar had appreciated by about 50% against the Japanese yen, Deutsche Mark, French franc, and British pound, the currencies of the next four biggest economies at the time. In March 1985, just before the G7, the dollar reached its highest valuation ever against the British pound, a valuation which would remain untopped for over 30 years. This caused considerable difficulties for the American industry, but at first, their lobbying was largely ignored by the government. The financial sector was able to profit from the rising dollar, and a depreciation would have run counter to the Reagan administration’s plans for bringing down inflation. A broad alliance of manufacturers, service providers, and farmers responded by running an increasingly high-profile campaign asking for protection against foreign competition. Major players included grain exporters, the U.S. automotive industry, heavy American manufacturers like Caterpillar Inc., as well as high-tech companies including IBM and Motorola. By 1985, their campaign had acquired sufficient traction for Congress to begin considering passing protectionist laws. The negative prospect of trade restrictions spurred the White House to begin the negotiations that led to the Plaza Accord.
The devaluation was justified to reduce the U.S. current account deficit, which had reached 3.5% of the GDP, and to help the U.S. economy to emerge from a serious recession that began in the early 1980s. The U.S. Federal Reserve System under Paul Volcker had halted the stagflation crisis of the 1970s by raising interest rates. The increased interest rate sufficiently controlled domestic monetary policy and staved off inflation.
However, a strong dollar is a double edged sword, inducing the Triffin dilemma which, on the one hand, gave more spending power to domestic consumers, companies, and to the US government, and on the other hand, hampered US exports until the value of the dollar re-equilibrated.
Trade Deficit
While for the first two years, the US deficit only worsened, it then began to turn around as the elasticities had risen enough that the quantity effects began to outweigh the valuation effect. The devaluation made U.S. exports cheaper to purchase for its trading partners, which in turn allegedly meant that other countries would buy more American-made goods and services. The Plaza Accord failed to help reduce the U.S.–Japan trade deficit, but it did reduce the U.S. deficit with other countries by making U.S. exports more competitive.
Objective Failure
The Plaza Accord was successful in reducing the U.S. trade deficit with Western European nations, but largely failed to fulfill its primary objective of alleviating the trade deficit with Japan. This deficit was due to structural conditions that were insensitive to monetary policy, specifically trade conditions. The manufactured goods of the United States became more competitive in the exports market, though were still largely unable to succeed in the Japanese domestic market due to Japan’s structural restrictions on imports. The Louvre Accord was signed in 1987 to halt the continuing decline of the U.S. dollar.
Louvre Accord
The Louvre Accord was an agreement, signed on February 22, 1987, in Paris, that aimed to stabilize international currency markets and halt the continued decline of the US dollar after 1985 following the Plaza Accord.
Currency Interventions Don’t WorkThe lead chart shows that the dollar had already started to fall by the time the Plaza Accord agreement was made (yellow highlights). The accord did not reverse any trends although perhaps it goosed the weakening that already started. And it failed totally on the primary mission vs the Yen.Then the dollar continued to decline after the Louvre Accord tried to halt the decline (light orange highlights). So the Louvre Accord did not work either.Then for decades, Japan tried to depreciate the Yen with currency interventions and failed. Now Japan is struggling to strengthen the Yen, also with interventions.Finally, please recall the Bank of England vs George Soros. So don’t tell me these forex currency interventions work.Debt Write DownsFacing deflation, China’s best bet would be to allow more bankruptcies and write down debt. However, China is highly unlikely to do so because the state owned enterprises would take a hard hit.Someone has to pay a price and China may end up doing what Japan did, stretching the problem out for decades in a foolish attempt to avoid anyone paying a price.Meanwhile, China is still digging a hole with unproductive debt, just as Japan did.Recall that Fed Chair Ben Bernanke advised Japan to write down debt to escape deflation but Japan didn’t. As is typical with monetary hypocrites, Bernanke failed to do so at our turn in the Great Recession.Instead, Bernanke embarked on massive QE that ultimately froze the US housing market when Jerome Powell continued Bernanke’s mistake during the Covid pandemic.Reserve Currency CurseThere is no mix of tariffs and other policies that would shrink the trade deficit without causing other problems elsewhere.And Trump has threatened 100 percent tariffs on any country that tries to end US dollar reserve currency status.However, Trump’s goals are so conflicting that he simultaneously needs a stronger dollar to fight inflation, but a weaker one to increase exports.This is the reserve currency curse, exacerbated in 1971 when Nixon ended dollar redeemability for gold.Should We Take Trump Seriously or Literally on Huge Tariff Hikes?On December 15, I asked Should We Take Trump Seriously or Literally on Huge Tariff Hikes?
Companies are mounting a campaign to soften the Trump’s trade threats, but Trump’s team says he is serious.
As long as Trump insists on contradictory actions, I suggest we should neither take Trump seriously nor literally.If we restrict ourselves to single promises, O.K. Trump will hike tariffs.But I’ll go with Bessent: “extreme positions will be eventually watered down during discussions with trading partners.”What About the Fiscal Deficit?Anyone who thinks Trump will balance the fiscal deficit via tariffs is flat out crazy.That idea should not to be taken either literally or seriously.The Bond Market Doesn’t Believe Trump Is Serious About the Deficit, and neither do I.Finally, the title of this post says “Currency Wars Will Be Next”. More accurately they are underway already.China is devaluing the yuan in advance of Trump’s tariff hikes. And tariff hikes will further weaken the yuan.For discussion, please see China’s 10-Year Bond Yield Hits New Record Low on Disappointing Data
The Japanification of China takes another big leap forward. And a huge fight with Trump is coming up.
A Word About DOGEQuestion of the Day: Do You Have Any Faith that Sheriff DOGE Will Reduce the Fiscal Deficit?If you do, you shouldn’t.More By This Author:Dear Fed, Please Shut Up Already, Stop The Forward GuidanceTwo Recession Indicators, What Do They Say Now?Real Spending Rises 0.3 Percent, Real Disposable Income Up 0.2 Percent
