Wednesday, August 7, 2019

Weaken the dollar to deal with China? Not the real problem, Donny.

Econofact discusses whether the US should weaken the dollar.
An important determinant of the value of the dollar is the expected return on U.S. assets. This return, in turn, depends on the current and future expected strength of the economy (which helps determine the returns on U.S. investments, including the policy interest rate set by the Federal Reserve). The figure illustrates this. It shows that the sharpest sustained appreciation of the dollar over the past two decades began in mid-2014 as the economy of the United States expanded more quickly than many of its major trading partners.

While a strong dollar normally tends to be associated with relative strength in the overall economy, dollar strength makes U.S. exports more expensive for foreigners, and imports cheaper for U.S. residents, diverting some of the benefits from growth away from manufacturing and other sectors engaged in international trade. A stronger dollar exerts competitive pressure on U.S. exporting and import-competing firms, even though some of them may simultaneously benefit to some degree from the higher domestic demand driving relative U.S. growth and a stronger dollar. Firms that do most of their business abroad, or that face intense competition from imports, may actually suffer on balance. This possibility lies behind concerns that a strong dollar could compromise growth by harming manufacturing. At the same time, cheaper imports help manufacturers that import inputs used in their own production. What do the data say? On balance, it is hard to see any consistent relationship between dollar strength and manufacturing employment (see left axis in the chart above, which depicts manufacturing employmentrelative to total non-farm employment). For example, over the period 2001-09, which saw the steepest historical fall in manufacturing employment, the dollar weakened on average.

If the exchange rate becomes the target of policy, how would the government go about weakening a strong dollar? The U.S. fiscal stimulus owing to the December 2017 tax cuts and subsequent increased government spending contributed to the strength of the economy and the strong dollar.

Tapering this stimulus, as the IMF has recommended, would weaken the dollar, but this seems unlikely any time soon. (President Trump and Congress have shown no inclination to reverse the tax cuts passed in 2017 or reduce the levels of spending. Indeed, on August 2, 2019 President Trump signed new legislation to extend the Federal debt limit and relax spending caps for an additional two years.) Alternatively, dollar assets would become less attractive if the Federal Reserve lowered interest rates. This is one reason behind President Trump’s calls for the central bank to do so. But the Federal Reserve sets monetary policy to achieve its dual mandate of low inflation and high employment, and the exchange rate’s value is a result of that monetary policy setting, not its main determining factor. A policy of lowering interest rates to weaken the dollar, rather than focusing on the dual mandate, is letting the tail wag the dog. Moreover, cutting interest rates systematically when the economy is strong in an effort to weaken the dollar would risk higher inflation, which, just like a strong dollar, would raise the foreign prices of U.S. goods and work to undermine the U.S. competitive position in global markets.
That last point is where you could certain have a couple of conspiracy theories involving Trump. One is relatively straightforward – lower interest rates likely gives the economy a better chance to keep growing through Trump’s re-election bid in 2020.

The other involves the high levels of debt that Trump and his family are rumored to have as part of their real estate deals. Lower rates make it easier to pay back those debts. If we had Trump’s tax and asset information, we’d have a better idea if that was a reason behind the trade wars. Sounds like another reason we need to know what Trump owns (or owes), doesn’t it?

Back to the EconoFact article – should the Fed and US Treasury step in to manipulate the value of the dollar?
Are there policies to manage the value of the dollar without diverting monetary policy from its primary targets? Direct intervention by the U.S. Treasury in the foreign exchange market offers one possibility, and several economists have advocated just such a move to counteract potential currency manipulation by foreign countries. In such operations, the Treasury would use dollars to buy foreign currency bonds, bidding up the relative prices of foreign currencies and weakening the dollar. The Treasury can intervene through its Exchange Stabilization Fund (which would give it just under $23 billion to sell, although the Fed could join the Treasury, as it has in the past, to sell U.S. bonds on its balance sheet for foreign bonds, without altering its interest-rate policy). Foreign exchange interventions might have to be big to move markets in a sustained way. For example, in the fiscal year 2019 through June, the Federal government issued $747 billion in dollar bonds to finance its deficit, or about $83 billion per month (and 23 percent higher than the same period a year earlier). All else being equal, these big increases in the supply of dollar-denominated bonds should weaken the dollar as investors diversify their increased U.S. bond holdings into foreign currencies, but although that was not the reason these bonds were issued, the dollar has not fallen. Given the size of international bond markets, would another few billions (the maximum size of past interventions) make a difference?
So it would take a lot of dollars to try to pull that off, and likely the markets would be so spooked by such a move that it would likely cause a lot more damage than any help it might offer in juicing the economy.

China also seemed to want to soothe some concerns with a move today designed to keep their currency from dropping past a certain point.
On Wednesday, the People’s Bank of China (PBOC) set its yuan fixing at 6.9996 per dollar, weaker than Tuesday’s fixing but stronger than the 7-per-dollar level the yuan initially breached Monday for the first time in more than a decade. However, the PBOC allows the yuan to move 2% in either direction from its midpoint fixing, meaning the currency could still weaken past 7-per-dollar and remain within range.
UW’s Menzie Chinn follows up to that report and notes that while China’s currency might be a bit low, it should be depreciating vs the dollar, given the slowdown in China's economy and the US's trade situation with China.

So in reality, the overly-strong dollar has little to do with trade, but is more an effect of too much sugar being given to the economy due to the GOP Tax Scam. Likely Trump is unhappy with this more because manufacturing is already slowing down in America, and now a cheaper Chinese currency is hammering the export markets that might keep that industry afloat.

And because a lot of blue-collar took a chance on Trump in the hopes that he will bring back blue-collar jobs, if those jobs start falling away, so does any chance Trump has of winning in 2020. Between that, the stock market's recent tumble, and his debt problems leading to a need for lower interest rates, that's the bigger reason that Trump has been squawking about trade this week.

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