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The United States With a Stronger Dollar

The United States With a Stronger Dollar

Source: Taringa

Source: Taringa

By Jacob Hess

The newly elected President Donald Trump is faced with controversial issues every day, but lately, one has kept him tossing and turning in his presidential bed. According to Huffington Post, President Trump was reported to have “called his national security adviser, retired Lt. Gen. Mike Flynn” for advice on his dollar policy at 3 a.m. While his question might have been ill-timed, the relevance of dollar fluctuations to the current state of the U.S. economy is certainly something Trump should be acknowledging. In particular, the value of the dollar affects the net exports part of gross national product and trade deals which are affected by foreign exchange movement.

At the Bretton Woods  in 1944, the global economy unhinged its currencies from the value of gold and created the exchange rate system to moderate inflationary fluctuations. Nations and their governments would now be concerned with how their local currencies measured up against foreign currencies. For example, developing nations, like China and Brazil, need to design policies that maintain a stable rate of exchange so that foreign debt does not hinder the growth of their economies. A weaker renminbi or real (China’s and Brazil’s currency) can invite foreign investors to invest more capital into the Chinese or Brazilian business because relatively their currency is stronger.

The effects of capital inflows (and outflows) have a direct effect on how a country grows. The  for gross national product is often broken into four main categories: consumption, investment, government spending, and net exports. Currency fluctuations can cause this last category, net exports, to vary from period to period. A paper by Federal Reserve economists Chien and Morris discussed the effects a stronger dollar might have on the U.S. economy earlier this year.

They found that a two-year period of U.S. dollar strengthening corresponded with a negative net exports effect (which is calculated by subtracting imports from exports) on GDP which has shrunk to about 1 percent in 2016. The largest contraction in net exports occurred in the first quarter of 2015 when net exports had a -1.14 percent drag on total GDP. The economists concluded that, “the new episode of appreciation of the dollar that began over the past several months is likely to hurt the current growth rate of GDP through an increase in imports,” referring to a 3.75 percent increase in the value of the dollar between election night and the date the paper was published.

The appreciation in that period doesn’t appear to be that much, but a five-year chart of the U.S. dollar spot price reveals that foreign exchange markets have the dollar valued at its peak. Some view this as a sign of financial stability in the United States as a stronger currency usually denotes that investors demand it more than other currencies. That is not necessarily the case. Like an article in The Economist suggests, the movement of the U.S. dollar should be considered in conjunction with why that movement is occurring. Unfortunately, there has not been any large sudden upswing in demand for U.S. goods, so why are people clamoring to get their hands on some greenbacks?

It just so happens that the U.S. is one of the world’s leading producers of debt. As the Federal Reserve increases interest rates (and the rest of the central banks don’t), Treasury debt is paying a higher interest rate relative to other countries’ debt. Selling more debt does not mean the economy is growing. Government deficit spending is the most unsustainable part of the GDP equation as it leads observers to lose confidence in the government’s policies. Hypothetically, when confidence in the government is lost, the economy starts to become more financially unstable, something a rising dollar isn’t supposed to indicate.

President Trump won the election on his call for a 4 percent growth rate, trade deal renegotiations, and a return of outsourced jobs to the United States. Forbes discusses his three-pronged promise and how it will, in the end, lead to an economic policy that pursues a stronger dollar. Even though these goals appear to be hopeful and optimistic, they altogether ignore the fact that the U.S. dollar is at 5-year highs and liable to be a drag on net exports. Janet Yellen’s Federal Reserve has attempted to acknowledge this predicament, but the new leader of the U.S. refuses to back off his fiscally loose agenda.

Source: Euractiv

Source: Euractiv

One part of his agenda involves renegotiating major trade deals with some of the U.S.’s largest trading partners. Using tweets and other media outlets, Trump has already managed to get major auto companies to return to the United States to recover a couple thousand jobs. Once again, policies like these sound economically beneficial, but having large amounts of capital outflows has proven to be healthy.

In another paper by the Federal Reserve, Senior Economist Yi Li Chien asserted that U.S foreign assets actually generate better return than U.S. foreign liabilities by a difference of almost 3.3 percent. In short, investments in countries outside the U.S. pay us more than foreign investments in the U.S. cost. By renegotiating trade deals and hassling companies to return to the United States, Trump is endangering these premium assets that allow us to run such large export deficits every year.

What do these trade adjustments do to the U.S. dollar value? In short, the dollar will start to strengthen even more as foreign consumers and firms are forced to buy more U.S. dollars to do business with the companies now embedded here. Yes, more jobs return to the United States, but a stronger dollar also results in lower relative demand for a multinational’s goods leading to a lower net income, and perhaps, the need to cut jobs.

It seems inevitable. The U.S. dollar is going to experience one of its strongest years in 2017 with higher interest rates enticing investors to buy more Treasury debt. How does Trump embrace this trend while encouraging economic growth to continue to increase from its near anemic pace?

First, President Trump’s trade renegotiations need to be rethought out, and perhaps, even scrapped if they continue to be aggressive in nature. The business sector is in a fragile state with borrowing getting more and more expensive, and any contraction in corporate earnings could hurt business investment, a key section of GDP.

Second, President Trump’s massive infrastructure program needs to be strategic and surgical. If another “stimulus package” is to be introduced, it cannot be a blanket of money carelessly thrown over the economy. Instead, the government needs to identify particular opportunities to improve the inner mechanisms of the economy while avoiding areas that are healthy. Overspending can lead to more debt which leads to a higher probability of a stronger dollar.

Finally, President Trump needs to stop being precocious with foreign allies (and enemies) on Twitter and in private. The combination of international uncertainty and a rising U.S. dollar relative to foreign currencies can be a dangerous mixture leading to deflationary recessions. The Federal Reserve is already in the process of fighting off a bout of deflation, and any contradictory policy from Trump could be dangerous.

It may seem illogical that Trump is calling his aides in the middle of the night about his dollar policy, but in reality, it could be one of the most important parts of his economic policy. Even if the new administration’s policy respected the current U.S. dollar trend, unfavorable exchange rates will be an issue that businesses will have to grapple with this year.

   

 

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