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Trump hopes to escalate a tariff war — with a currency war

Brian Cheung

President Donald Trump has called on the U.S. Treasury and the Federal Reserve to weaken the U.S. dollar, arguing that American exports are being hurt by other countries’ efforts to devalue their own currencies.

But some are warning that the president’s efforts could negatively impact GDP growth in the short-term, and start a currency war that could backfire in an even stronger dollar.

“Historically, however, attempts to weaken the dollar have met with mixed success and there are good reasons to believe that any intervention now would fail,” Capital Economics wrote in a note July 8.

Over the past few weeks, Trump has accused China and Europe of manipulating their currencies by easing monetary policy and weakening their currencies. On July 3, Trump tweeted that countries abroad have been “playing [a] big currency manipulation game and pumping money into their system in order to compete with [the] USA.”

Trump argues that a stronger dollar is hurting U.S. exports by making them more expensive for buyers abroad — damaging the administration’s efforts to reduce the trade deficit. Boosting exports have been the center of Trump’s game of chicken on tariffs with longtime trade rival China, but also close neighbors Mexico and Canada.

His proposal? Get the Federal Reserve to “match” the actions of the European Central Bank and the People’s Bank of China by lowering interest rates and taking some steam out of the U.S. dollar.

Trump has repeatedly called on the Fed to ease policy.

The idea of manipulating the U.S. dollar is not limited to the White House, or even the GOP. Massachusetts Democrat and 2020 presidential candidate Elizabeth Warren has proposed “actively managing” the U.S. dollar to boost exports and domestic manufacturing.

“We should consider a number of tools and work with other countries harmed by currency misalignment to produce a currency value that’s better for our workers and our industries,” Warren writes in her economic plan.

But there are two concerns: the consequences of intervening in currency valuation, and whether or not the Fed would be willing to help out.


Some worry that manipulating the U.S. dollar would simply push other countries to further devalue their currencies, spurring a currency war that could exacerbate the trade spats between the U.S. and other nations.

“More broadly, Trump's penchant for verbally intervening in the foreign exchange market, and now implicitly threatening intervention may risk weaponizing the currency market,” Bannockburn Global Forex’s Marc Chandler wrote July 7.

Over the past few months, the U.S. dollar has appreciated against major currencies like the Euro, the Chinese yuan, and the British pound. The U.S. dollar index has fluctuated over the last six months, but has risen from 95.90 as of January 8, to 97.31 as of Monday afternoon.

Capital Economics wrote that weakening the dollar would be countered by other countries and could “backfire” if long-term interest rates spiked as the central bank sold assets to stabilize the dollar. In the short-run, they warn that a weaker dollar would increase import prices and reduce the purchasing power of U.S. households and businesses.

“[W]e would view any action to deliberately weaken the dollar as negative for near-term GDP growth,” Capital Economics wrote.

But the question remains about whether the president could spur any action on weakening the U.S. dollar in the first place. The key is whether the Fed would get involved.

Will the Fed play along?

The Federal Reserve has not acknowledged interest in pulling the strings on the U.S. dollar.

Federal Reserve Chairman Jerome Powell speaks speaks at "C. Peter McColough Series on International Economics: A Conversation with Jerome H. Powell" at the Council on Foreign Relations in New York, U.S., June 25, 2019. REUTERS/Brendan McDermid
Federal Reserve Chairman Jerome Powell speaks speaks at "C. Peter McColough Series on International Economics: A Conversation with Jerome H. Powell" at the Council on Foreign Relations in New York, U.S., June 25, 2019. REUTERS/Brendan McDermid

Asked about the Warren proposal in the central bank’s June 19 policy setting meeting, Fed Chairman Jerome Powell pointed out that the central bank’s dual mandate is stable prices and maximum employment, not exchange rate policy.

“The U.S. Treasury has responsibility for exchange rate policy, not the Fed, and we don’t comment, in that sense, on the level of the dollar,” Powell said.

UBS wrote June 26 that at the moment, the U.S. is juggling free capital flows and independent monetary policy, at the sacrifice of a fixed exchange rate. But Trump wants all three, a concept in international finance known as the “impossible trinity.” Having a fixed exchange rate would imply that the central bank would have to give up its independence and base monetary policy decisions around keeping the U.S. dollar at desired levels, as it does not do right now.

“The Administration's implicit preference for a weak USD has always been problematic in the context of expansionary fiscal policy, strong economic growth and tighter monetary policy,” UBS wrote.

Technically, Trump can still address the dollar without the Fed’s help. Per a 1934 law, the U.S. Treasury and the executive branch can deal in gold and foreign exchange for the purposes of “stabilizing” the U.S. dollar.

But Capital Economics writes that the Treasury has an “exceptionally flimsy leash” on its own standing, since the Treasury only has about $123 billion in funds in its Exchange Stabilization Fund. Such a figure, they argue, is too small a reserve to have an impact in a foreign exchange market where China is sitting on over $3 trillion in foreign currencies (not just including the dollar).

“[A]ny attempt by the Treasury to intervene unilaterally would be bound to fail, unless it could rely on the Fed’s support,” Capital Economics wrote July 8. The Fed has teamed up with the Treasury before, most notably in 1995 when they bought marks and yen.

But with no indication from the Fed that it is willing to take on new assets on the balance sheet, in addition to concerns over bending to the White House, it is unclear if the Fed would be willing to try such a move again.

Trump may not be so patient.

ING wrote July 8 that if the dollar doesn’t fall later this year, they would expect more pressure on the U.S. Treasury to take direct action.

Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.

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