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Economic Insights

The U.S. president has expressed concerns about a strong dollar, but his growth initiatives could bolster the greenback versus other currencies.

 

In Brief

  • President Donald Trump’s concerns about the effect of a strong U.S. dollar on U.S. competitiveness stand at odds with his proposed growth agenda, which could support a stronger U.S. currency. 
  • Dollar strength seems a likely outcome of pro-growth policies, creating headwinds for export-dependent companies, but a more favorable environment for U.S.-centric companies.
  • If Trump wishes to counter the effects of dollar strength, tariffs could emerge as a policy lever. Such a move could result in higher U.S. inflation, along with in-kind retaliation from U.S. trading partners.
  • A more broad-based border-tax adjustment is another option currently under discussion in the U.S. Congress. 
  • The key takeaway: Given the current uncertainty, close monitoring of policy developments and a flexible approach to portfolio management in 2017 may be necessary for investors. 

 

While it remains to be seen how President Donald Trump’s pro-growth policies will be designed, whether they will be passed by the U.S. Congress, and when they may be implemented, any successful outcomes from those policies suggest support for the U.S. dollar. Trump’s concern that a strong dollar is “killing us,” in terms of U.S. competitiveness, stands in stark contrast to his proposed growth agenda of infrastructure spending, reduced taxes, and less regulation, which independently and collectively bolster a more robust U.S. currency. 

Trump’s wish list may include a weak U.S. dollar, in addition to previously stated items such as a more attractive investment environment, meaningful job growth, and a stronger economy. But global currency markets seem poised to remind him that currency valuation may not be at his discretion. If Trump believes it necessary to counter the effects of dollar strength, tariffs could emerge as a policy lever—but with significant consequences.

Persistent U.S. economic growth and less accommodative monetary policy led to increased global interest in the U.S. dollar even before Trump announced his candidacy in June 2015. The U.S. Dollar Index (DXY), which tracks the currency against a basket of its global counterparts, rose more than 20%, from 80 in mid-2014 to an average of 97 for 2015, the same level that preceded Trump’s election in November 2016. Since his election, the index has risen another 3.7%, to 100.6, as of February 9, 2017, according to Bloomberg, in anticipation that pro-growth policies likely would produce a pro-dollar environment.

Dollar Boost?
Although policy details are still lacking, proposed infrastructure spending, tax reform, and reduced regulation suggest a more vigorous U.S. economy and an attractive investment environment. A stronger U.S. currency is an expression of investor interest in such an improved environment. Higher interest rates associated with a better economic growth also serve to attract investor interest. Such an environment also should enable the U.S Federal Reserve (Fed) to hike short-term rates as it pursues rate normalization, thereby attracting still other investors and providing further support to the dollar.

Since his inauguration, Trump’s meetings and executive orders have underscored his “America First” theme, a theme that might also be interpreted as “dollar first.” When he met with manufacturers on his first day in office, for example, he directed them to return in 60 days with suggested changes that would enable faster development of manufacturing plants and jobs. He promised advantages to companies that make their products in the United States. His order to withdraw the United States from the Trans-Pacific Partnership (TPP) trade pact with 11 Asian nations (never ratified by Congress) was interpreted by currency markets as unfavorable to other participating countries, particularly Vietnam. Presidential orders to pursue development of the XL and Dakota pipelines, using exclusively American-made steel pipe, suggest regulatory changes will favor economic growth and efficiency. 

Opportunities and benefits of a pro-growth environment were not lost on some global manufacturers. Electronic component maker Foxconn expressed interest in investing US$7 billion to build a flat-panel display manufacturing plant in the United States, potentially creating 40,000 jobs. Meanwhile, Toyota announced plans to invest $10 billion in the United States over five years. Potential U.S. corporate tax reform also promotes a business-friendly environment and related currency strength. Repatriations of foreign cash as a result of lower domestic taxes could also further strengthen the dollar.

Trump’s Dilemma
Trump’s policies seem to promote the dollar strength that he described as damaging to U.S. corporate competitiveness in a recent interview with The Wall Street Journal.  His comments did not touch on the fact that his preferred policies may actually further support the greenback. Pro-growth initiatives and presidential directives that create jobs and strengthen the U.S. economy also create and strengthen demand for the U.S. dollar. Therein lay the seeds of a potential dilemma for Trump’s growth program.

The dilemma unfolds when a stronger dollar increases the cost of U.S. exports, reducing profit margins and/or market share of U.S. multinational companies. Earnings of U.S. multinationals further suffer as foreign revenues translate into fewer, stronger dollars. Dollar strength also creates cheaper imports that can affect demand for U.S. produced goods, potentially reducing U.S. production, growth, and jobs. 

While Trump may prefer less dollar strength—because a more richly valued U.S. currency could impede his sprint toward faster economic growth and more manufacturing jobs—he may have to accept a stronger currency as a consequence of successful fiscal policies.

Tariff Solution?
Meanwhile, an unwillingness to accept the impact of dollar strength could lead to the implementation of other policies currently under consideration in Washington. To compete against cheap imports, tariffs could be levied against goods imported from certain nations. Tariffs would increase the cost of imports, offsetting the cheapening effect of dollar strength and permitting a more favorable environment for domestic producers. Such actions include risk of several consequences, including higher domestic inflation and potential retaliation by other countries, similar to the aftermath of the Smoot-Hawley Tariff Act of 1930 (Smoot-Hawley).* Economic history and theory both convey that tariffs may, ultimately, lead to even greater dollar strength. 

A more broad-based border-tax adjustment is another option currently under discussion by U.S. House majority leader Paul Ryan (R-WI) and U.S. Senate majority leader Mitch McConnell (R-KY). Such a proposition is, in effect, a tax on imports and a tax credit for exports, and also seems to address concerns of exporters as well as domestic producers. However, a “tax” on imports of apparel, oil, autos, and auto parts suggests inflationary consequences at the most basic levels of consumption, resulting in some impairment in economic growth as well. Tax credits to exporters would temporarily put them on more level terms with competing companies that enjoy a currency advantage, but retaliation by tariff-hit nations—against what may be perceived as an unfair advantage for the United States—may be a likely response. 

Details of tariffs and border-tax adjustments have yet to be identified; an effective solution may in the making. However, until such a development, dollar strength seems a likely outcome of pro-growth policies, creating headwinds for export-dependent companies, but a more favorable environment for U.S.-centric companies. If tariffs become policy, different investment opportunities will unfold. Given the current uncertainty, close monitoring of policy developments in Washington and the capitals of other major global economies, and a flexible approach to portfolio management in 2017, may be necessary conditions for attractive returns. 

 

*The Smoot-Hawley Tariff Act, formally the United States Tariff Act of 1930, also called Hawley-Smoot Tariff Act, was a piece of U.S. legislation (signed into law June 17, 1930) that raised import duties to protect American businesses and farmers, adding considerable strain to the international economic climate of the Great Depression.

 

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