Currencies

Subterms

    Latest story

    163 Shares60 Views

    Why Donald Trump’s plan to weaken the dollar is flawed | Kenneth Rogoff

    by

    Now that US President Donald Trump’s tariff war is in full swing, investors around the world are asking: what’s next on his agenda for upending the global economic order? Many are turning their attention to the “Mar-a-Lago Accord” – a plan proposed by Stephen Miran, chair of Trump’s Council of Economic Advisers, to coordinate with America’s trading partners to weaken the dollar.At the heart of the plan is the notion that the dollar’s status as the world’s reserve currency is not a privilege but a costly burden that has played a major role in the deindustrialisation of the American economy. The global demand for dollars, the argument goes, drives up its value, making US-made goods more expensive than imports. That, in turn, leads to persistent trade deficits and incentivises US manufacturers to move production overseas, taking jobs with them.Is there any truth to this narrative? The answer is yes and no. It’s certainly plausible that foreign investors eager to hold US stocks, bonds, and real estate could generate a steady flow of capital into the United States, fuelling domestic consumption and boosting demand for tradable goods such as cars and non-tradables such as real estate and restaurants. Higher demand for non-tradable goods, in particular, tends to push up the dollar’s value, making imports more attractive to American consumers, just as Miran suggests.But this logic also overlooks crucial details. While the dollar’s reserve-currency status drives up demand for Treasuries (Treasury bills, Treasury bonds, and Treasury notes), it does not necessarily increase demand for all US assets. Asian central banks, for example, hold trillions of dollars in Treasury bills, to help stabilise their exchange rates and maintain a financial buffer in the event of a crisis. They generally avoid other types of US assets, such as equities and real estate, since these do not serve the same policy objectives.This means that if foreign countries simply need to accumulate Treasury bills, they don’t have to run trade surpluses to obtain them. The necessary funds can also be raised by selling existing foreign assets such as stocks, real estate, and factories.That is precisely what happened in the 1960s through the mid-1970s. By then, the dollar had firmly established itself as the global reserve currency, yet the US was almost always running a current account surplus – not a deficit. Foreign investors were accumulating US Treasuries, while American firms expanded abroad by acquiring foreign production facilities, either through direct purchases or “greenfield” investments, in which they built factories from the ground up.The postwar era was hardly the only time when the country issuing the world’s reserve currency ran a current account surplus. The British pound was the undisputed global reserve currency from the end of the Napoleonic wars in the early 1800s until the outbreak of the first world war in 1914. Throughout that period, the UK generally ran external surpluses, bolstered by high returns on investments across its colonial empire.There is another way to interpret the US current account deficit that helps explain why the relationship between the exchange rate and trade imbalances is more complicated than Miran’s theory suggests. In accounting terms, a country’s current account surplus equals the difference between national savings and investment by the government and the private sector. Importantly, “investment” here refers to physical assets such as factories, housing, infrastructure, and equipment – not financial instruments.When viewed through this lens, it is clear that the current account deficit is influenced not just by the exchange rate but by anything that affects the balance between national saving and investment. In 2024, the US fiscal deficit was 6.4% of GDP, significantly larger than the current account deficit, which was under 4% of GDP.While closing the fiscal deficit would not automatically eliminate the current account deficit – that would depend on how the gap is closed and how the private sector responds – it is a far more straightforward fix than launching a trade war. Reducing the fiscal deficit would, however, involve the difficult political task of convincing Congress to pass more responsible tax and spending bills. And unlike a high-profile trade confrontation, it wouldn’t cause foreign leaders to curry favour with Trump; instead, it would shift media attention back to domestic politics and congressional negotiations.Another key factor behind the current account deficit is the strength of the American economy, which has been by far the most dynamic among the world’s major players in recent years. This has made US businesses particularly attractive to investors. Even manufacturing has grown as a share of GDP. The reason employment has not kept pace is that modern factories are highly automated.skip past newsletter promotionafter newsletter promotionMiran’s plan, clever as it might be, is based on a flawed diagnosis. While the dollar’s role as the world’s leading reserve currency plays a part, it is just one of many factors contributing to America’s persistent trade deficits. And if the trade deficit has many causes, the idea that tariffs can be a cure-all is dubious at best. Kenneth Rogoff is professor of economics and public policy at Harvard University. He was the IMF’s chief economist from 2001-03.© Project Syndicate More

    More stories

    • 138 Shares109 Views

      in US Politics

      Is Trump driving the US into a recession? – in charts

      by

      Prospects for the US economy have cooled significantly in a matter of months. After outperforming its international peers last year, warning lights are flashing on a dashboard of economic indicators as analysts warn that Donald Trump’s erratic approach is hitting the world’s largest economy.Fears of a US recession this year are growing, in what is being called a “Trumpcession”, amid a sharp decline in business and consumer confidence as the president threatens punitive import tariffs on US allies and enemies alike.Most economists reckon a recession – defined as two consecutive quarters of shrinking economic output – can be avoided. But it is clear there are storm clouds gathering within the president’s first 100 days back in the White House.GDPUS growth in gross domestic product (GDP) had outpaced international peers in recent years, and since the Covid pandemic in particular – helped by the Biden administration pumping billions of dollars into the economy through the Inflation Reduction Act. The former president did not get much credit, though, as voters felt the squeeze from the period of high inflation triggered by the pandemic and Russia’s war in Ukraine.This week, the Atlanta Federal Reserve’s GDPNow, which measures GDP economic growth in real time, suggested the US economy would contract at an annual rate of 2% in the first quarter. However, this widely followed indicator can be volatile, and it is heavily influenced by the US trade deficit, which soared in January.Trade balanceThe US goods trade gap surged to $153.3bn in January. This was driven by record import volumes, an increase of $36.2bn to $329.5bn in total, as US businesses rushed to bring shipments into the country to avoid potential tariffs.US gold importsA significant driver of the import rise was inbound shipments of “finished metal shapes”, which include bars of gold. The trend is also attributed to traders rushing to get ahead of potential US tariffs. A widening trade deficit would normally weigh on a country’s GDP, because imports are subtracted from the measurement. But because gold bought to sit in a vault is not consumed or used in production, it is excluded.This means the Atlanta Fed is likely to be overestimating the hit to first-quarter GDP. Still, there are other signs that the US economy is cooling.InflationTrump had promised to “bring prices down, starting on day one” and “cut energy costs in half within 12 months after taking office”.Official figures show the headline annual rate as measured by the consumer price index was 2.8% in February, after an unexpected rise to 3% in January from 2.9% in December. Energy costs are down by 0.2% on an annual basis.The Organisation for Economic Co-operation and Development (OECD) said on Monday that Trump’s trade wars risked stoking inflation. It increased its US inflation forecast for 2025 to 2.8%, up from a previous estimate of 2.1% made in December.EmploymentThe US jobs market has boomed in recent years, and the unemployment rate dropped to 3.5% in early 2023, the lowest level since the year of the first moon landing in 1969. The rate has ticked higher in recent months, but remains historically low at 4.1%. This has been spurred by rapid growth in the numbers of jobs being added to the economy.Wage growth has also strengthened, and has remained above inflation since early 2023, helping households to rebuild some of their purchasing power lost during the recent rise in living costs.StocksThe US stock market has powered to record highs in recent years. Tech stocks and the “magnificent seven” – Alphabet, Amazon, Apple, Microsoft, Meta, Nvidia and Tesla – have led the charge in particular, buoyed up by investors betting on the growth of artificial intelligence.The Biden administration oversaw a strong stock market performance, helped by the economic recovery from the pandemic. However, Wall Street surged after Trump’s election victory in November, amid investor expectations for tax cuts that could increase company profits. Markets have been rattled in Trump’s first 100 days amid concerns over his erratic approach to the economy and the threat of tariffs hitting growth and stoking inflation.The US dollarThe US dollar had been rising sharply against other leading currencies, reflecting the strength of the economy and investor concerns that Trump’s policies could stoke inflation. Tariffs pushing up the price of imported goods, driving up inflation, could force the US Federal Reserve to hold back from cutting interest rates.With inflation having fallen back, the Fed cut its benchmark rate last year by a whole percentage point – from a range between 5.25% and 5% to between 4.25% and 4.5%. Higher inflation could limit its capacity for further rate cuts.A dramatically slowing economy could force the central bank to take action to lower borrowing costs. This has led to a pullback in the dollar in recent weeks.Washington has long held a “strong dollar” policy in the view that it supports the purchasing power of US consumers, helping to keep inflation low. The dollar is also used as the currency of choice for world trade and underpins the financial system. The US Treasury secretary, Scott Bessent, has said this approach is not changing. But Trump has argued that a weaker dollar would benefit US manufacturing by making exports cheaper for overseas buyers.Prices of inputs for manufactured productsBusiness surveys have shown a marked increase in input costs for US manufacturers, providing an early warning sign for growth and inflation. The price gauge on the Institute for Supply Management (ISM) manufacturing purchasing managers’ index (PMI) shows raw material costs rose sharply at the start of this year, in the first signs of supplier difficulties and discussions about who will pay for tariffs. The rise in input costs could dent US manufacturing output, and is likely to be passed on to consumers in the form of higher prices for finished goods.Consumer spendingUS consumer spending unexpectedly dropped in January for the first time in almost two years, with a fall of 0.2%, the biggest decrease in nearly four years. Cold temperatures in some parts of the country, as well as wildfires in California, were likely to have hit spending. However, some analysts warn consumer sentiment has taken a knock amid mounting concern over the strength of the economy. More

    • 113 Shares99 Views

      in US Politics

      What the weakening dollar means for the global economy

      by

      A near 10% drop in the value of the US dollar since its March high has given rise to two distinct narratives. The first takes a short-term perspective, focusing on how a depreciation could benefit the US economy and markets; the second takes the long view, fretting over the dollar’s fragile status as the world’s reserve currency. Both narratives contain some truth, but not enough to justify the emerging consensus around them.Several factors have combined to put downward pressure on the greenback (as measured by the DXY index of trade-weighted currencies) in recent weeks, resulting in a depreciation that has reversed almost half of the appreciation of the last 10 years within the space of months.As the US Federal Reserve has loosened monetary policy (actually and prospectively) in response to a worsening economic outlook, the income accruing to dollar-denominated safe havens, such as US government bonds, has declined. And with US-based investments having lost some of their attractiveness, there has been a shift in holdings in favour of emerging markets and Europe (where the European Union last month agreed to pursue deeper fiscal integration).There also are indicators of lower capital inflows into the United States. House purchases by foreigners appear to have decreased again, owing in part to the US government’s embrace of inward-looking policies and the weaponisation of trade and sanction measures.With the exception of Lebanon, Turkey and a few other countries that have experienced even sharper exchange-rate depreciations than the US, most currencies have strengthened against the dollar. But among those with appreciating currencies, the reactions to this generalised phenomenon have been far from uniform.Some countries, particularly in the developing world, have welcomed the reversal, because their previous currency weakness had been contributing to higher import prices, including for foodstuffs. Moreover, a weaker dollar provides them with greater scope to support domestic economic activities through more stimulative fiscal and monetary measures.But the reaction has been less welcoming in the other advanced economies. Japan and eurozone member states, in particular, fear that currency appreciation could threaten their own economic recovery from the Covid-19 shock. Also, the Bank of Japan and the European Central Bank now have to worry that they are not only reaching the limits of their policy effectiveness, but could also be putting their economies at greater risk of collateral damage and unintended consequences.In the US, meanwhile, the dollar’s depreciation has been welcomed as an overwhelmingly positive development for the economy, at least in the short term. After all, economic textbooks tell us that a weakening dollar boosts US producers’ international and domestic competitiveness relative to foreign competitors, makes the country more attractive for foreign investors and tourism (in price terms), and increases the dollar value of revenue earned overseas by home-based companies. That is also all good for US stock and corporate bond markets, which benefit further from the greater attractiveness of dollar-denominated securities when they are priced in a foreign currency.The longer-term consensus view is less positive for the US. The worry is that dollar depreciation will further erode the currency’s global status, which has already been weakened by the US policies of the past three years – from protectionism and weaponised sanctions to bypassing global standards and the rule of law.The more the dollar’s credibility is eroded, the more the US risks losing the “exorbitant privilege” that comes with issuing the world’s main reserve currency. A country in this position can exchange bits of printed paper or digital entries – currency creation – for the goods and services that other countries produce. It enjoys disproportionate influence over important multilateral decisions and appointments. And it benefits from others’ willingness to outsource to its own institutions the management of their financial wealth.Both of these (partly true) consensus narratives imply further significant dollar depreciation. While the immediate effects are theoretically positive, the practical situation is likely to be different, because so much economic activity is currently impaired by government restrictions and the reluctance of individuals and companies to return to previous consumption and production patterns. Around half of US states have now reversed or halted the process of economic reopening.Moreover, today’s positive market effects demand further qualification beyond the health crisis. Owing to the reliable and ample provision of liquidity, particularly by central banks, most valuations have already decoupled from economic and corporate fundamentals. Under these financial conditions, it is hard to imagine that a dollar depreciation will have any more than a marginal effect on real economic performance.As for the dollar’s role as a reserve currency, I am reminded of a simple principle I learned at university: it is hard to replace something with nothing. At this time, there simply is no other currency that can or will fill the dollar’s shoes. Instead, we will continue to see small pipes being built around the dollar. And, because none of these will be large enough to replace it, the eventual result will be a more fragmented international monetary system.As has happened before, the current consensus views on the dollar will probably end up overstating the long-term implications of short-term movements. Today’s dollar weakness is neither a boon to markets and the US economy nor an augury of the currency’s global downfall. But it is part of a larger, gradual fragmentation of the international economic order. The main factor in that process is the shocking lack of international policy coordination at a time of rising global challenges.• Mohamed El-Erian is chief economic adviser at Allianz. He served as chair of President Barack Obama’s Global Development Council and is a former deputy director at the IMF© Project Syndicate More