By Jason Marshall, MPP, Staff Writer, Brief Policy Perspectives
Although there’s still a little more than a month left before President-elect Donald Trump takes the oath of office, foreign exchange markets already are in motion. That trend is likely to continue given that the U.S. dollar surged to 14 year highs in November and the Federal Reserve is expected to raise interest rates later this month. The strengthening of the U.S. dollar, coupled with rising stock prices is a major reversal of market behavior during the election cycle. The Dow Jones Industrial Average (DJIA), which is a price-weighted average of 30 significant stocks, improved after the first Presidential debate, when Hillary Clinton was projected to win the presidency, and plunged on election night as Trump’s victory became more apparent.
The current appreciation of the dollar can be explained with some certainty. What it means for the future cannot. At least, not without any of President Truman’s one-handed economists. Though, as unpredictable as this election cycle has been, and as unstable as some of President-elect Trump’s policy positions have been, basic laws of economics have not changed. By understanding these rules, we can begin to make sense of the DJIA’s reversal; and see what is driving the surging U.S. dollar. Furthermore, by looking at past episodes of a surging dollar, we can attempt to predict what may happen in the upcoming years.
The U.S. dollar is a floating currency, meaning that its value isn’t fixed to an underlying asset such as gold. Rather, its value is determined by the supply and demand for dollars. Demand for U.S. Dollars has noticeably increased since Trump became president-elect. Investors are betting that President Trump will cut taxes and improve U.S. infrastructure, which will stimulate economic growth and increase the demand for credit. Prices of U.S. crude oil also jumped, as the Organization of the Petroleum Exporting Countries (OPEC) reached an agreement to limit production of crude oil. Although the U.S. is not a member of OPEC and does not need to adhere to this limitation, it is still a beneficiary of increasing global oil prices. Overall strong growth, lower than expected unemployment, and the prospect of future economic growth has increased demand for U.S. dollars.
This demand will likely convince Federal Reserve Chair Janet Yellen to increase interest rates and increase capital inflows to the United States, pushing the dollar up relative to other currencies as risk-averse investors flock to safe and profitable investments. As investors flock to U.S. assets, they are wary of other major global currencies for reasons that are unique to each country. For example, the Indian Rupee dipped to a six-year low against the dollar as President Narendra Modi surprisingly recalled the two highest Indian bank notes, the 500 and 1000-rupee (approx $7 and $15 respectively) notes. President Modi’s wished to remove ill-gained ‘black money’ from circulation but the program was poorly designed, and the shockwaves sent investors fleeing, effectively appreciating the U.S. Dollar the rupee.
Under relatively normal conditions, the effects of the dollar surging are interpreted differently by each of the political parties. Imports become cheaper as the dollar can stretch further. Exports drop and American goods and services become more expensive compared to foreign goods. As imports rise and exports fall, the likelihood of the U.S. trade deficit widening grows . The overall implications of the trade deficit are disputed; Mexico may have a $58 billion dollar trade surplus with the United States, however American consumers enjoy lower prices, and American producers enjoy lower prices on inputs.
What is concerning is the upcoming administration’s cry of “Americanism, not globalism.” The trade deficit might not be seen as a natural reaction to changes in relative prices, but rather that the system as a whole is rigged against the United States. The December 3rd edition of The Economist lays out this dilemma.
“A bigger deficit raises the chances that [President-elect Trump] act on his threats to impose steep tariffs on imports from China and Mexico in an attempt to bring trade into balance. If Mr. Trump succumbs to his protectionist instincts, the consequences would be disastrous for all.”
If President Trump acts on some of his more extreme proposals, such as his 35 percent tariff on domestic companies that move their operations overseas, the results would be far more damaging to the economy overall. These tariffs, as described by Rich Lowry in Politico, would be “a festival of special-interest lobbying, with businesses clamoring for government protection at the expense of everyone else.” Protectionism is a classic case of dispersed costs and concentrated benefits, that would raise prices to save a few, selected jobs.
It will be up to the new administration to take an economically responsible approach to globalization and free trade in a period of American economic strength. Critics of globalization have a valid point, it does have downsides and it does harm specific sectors. Manufacturing has been in decline as a share of the U.S. workforce since the 1940’s, and in absolute number since 1979. That trend is likely to continue, driven mainly by technological growth and the resulting automation, but also exacerbated by a surging dollar. It is likely that the dollar will continue to appreciate, but its effects after January 20th will be much harder to predict.