Is a Strong or Weak Dollar Good for the US? The $16 trillion Question

Reports suggest that recently President Trump asked National
Security Adviser Michael Flynn about whether it was a strong or weak dollar
that was in the US interest.
  According to the leaks, Flynn
suggested asking an economist.  
The simple question is very revealing for those of
us still trying to get a handle of the unorthodox new Administration. 
 First, it means that the President has not made up
his own mind, which implies more fluidity
than some of the strongly worded statements and tweets suggest.  Second,
it underscores our caution that the formal power structure may not apply.
Informal power structure may be more important.  There is always some
tension between how much authority the White House and in the cabinet.
 Trump’s style suggests much will kept in the White House.  Third, in
the early days of the Administration have been marked by a steady stream of
leaks, agitating the already tense relationship between the White House and
some parts of the media.
Many seem to be
asking the same thing about the dollar,
but the question is naive and misguided.
  It wrong assumes that the US
economy, or any modern economy, is a homogeneous entity instead of diversified
and complex system.    In the simplest terms, it might be more helpful
to recognize that there are winners and losers for different policy
configurations.  We already see it
with the coming debate over the so-called border adjustment (tax on imports and
a tax break for exports), as several large US businesses are on both sides.
The question
assumes a static and one-dimensional view. 
  What is strong and weak changes
over time  Also it may vary over the business cycle.  There are also
various measurements that can be used to give a holistic view.   Sometimes
the dollar can be strong against emerging market currencies and weaker against
other major currencies. There are real and nominal trade-weighted
measures and various equilibrium models, like
purchasing power parity and real effective exchange rates.  The euro may be undervalued for German producers, but it may
also be overvalued for Italian or Greek, and maybe French exporters.
Relative
business cycles may also be important.
 
For example, the
relative strength of the dollar since mid-2014 seems to be largely a function
of the diverging economic and monetary performance of the US.  The Federal
Reserve finished its unorthodox monetary policy and was preparing the market
for the beginning of a gradual normalization process.  Japan and much of
Europe was still in the early stages of their unorthodox efforts.  That is
the way the floating exchange rate should move:
Strong economies with tightening monetary policy have appreciating currencies.
 Weak economies with easy monetary policy
have weaker currencies.  Typically central bankers want the broad
measure of the currency to move in the direction of monetary policy.
The best answer
to give to President Trump, however, may be that it is in the US interest to
let market forces determine the value of the dollar.  
This is part of the agreements that the US not
only encouraged but insisted on at the G7 and G20.    It may not be at the level of a treaty, but it is an
important concession the US won.  At Bretton Woods, there was not doubt
there was going to be a fixed exchange rate regime of one kind or another.
 When Bretton Woods broke down, the necessity of floating exchange rates
became a virtue, and the US the most powerful advocate.
There may also
be a fundamental confusion of what the two-decade-old strong dollar policy
means. 
 It has not helped that various
officials themselves have offered different definitions.  It has not
helped that the strong dollar policy has been scoffed and often seemingly
intentionally misconstrued.
It was not, as
one Treasury Secretary suggested, difficult to counterfeit.
  It was never about the level, as
many commentators insisted upon mocking.  It was a signal to the world
that after a ten-year period of activism, the US would forswear the use of the
dollar as a bludgeon to beat policy concessions not from its enemies but allies, like Germany and Japan.

When Robert Rubin first announced the strong dollar policy in 1995, it was
meant to signal a break from the ill-fated Lloyd Bentsen’s stint at the head of
Treasury. 
 Bentsen had threatened Japan with
driving the dollar down against the yen if Japan did not make trade
concessions.  The US dollar fell sharply.


The US was
thought to be risking the role of the dollar in the world economy and the
funding of the budget deficit. 
   After the Maastricht Treaty,
many expected that the euro would replace the dollar as the world’s key reserve
asset.  Its current account surplus was thought to make the euro more
attractive than the dollar.  The strong dollar policy meant that the US would
not purposely devalue the dollar to reduce its debt burden.  In no way did
that commit the US to a monetary policy that whose goal was the external value
of the dollar however measured.  

The capitalist
rivalry was threatening the economic stability.
  An arms control agreement was
necessary.  That is what the strong dollar means.  The foreign exchange could be another terrain for
competition, but it would be ruinous.  So foreign exchange has been
de-weaponized. There is a self-policing process.  If a country strays too
far, it gets pulled back, like Japan in the early days of Abe’s Administration.
 Given some of the comments coming from the US Administration, it ought not to
be surprising that both Merkel and Abe have expressed a desire to talk about
the foreign exchange market with the US Administration.  

To be clear, the de-weaponization of the foreign exchange market does limit a country’s ability to pursue a monetary policy that is aimed at addressing the domestic economy. Although many observers decried quantitative easing as manipulation of the foreign exchange market, the G7 and G20 made no such demands.  For several years, many have cried wolf about currency wars.  This has paved the ground for a real currency war by de-sensitizing investors to the threat of a real currency war.  The unorthodox US President may clumsily stumble into one, if he is not careful.  

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