Can Donald Trump and Other Leaders Deflate Their Currencies?
- The US Dollar has dropped four-consecutive trading sessions through Tuesday while US President Trump has weighed in on its value
- Understanding the effectiveness and likelihood of exchange rate intervention first requires appreciating the motivations for it
- To move a currency there are multiple possible efforts that may be pursued, but they vary for effectivness and condemnation
Is There an Effort to Deflate the Dollar Afoot?
Through Tuesday, the Dollar has extended a remarkable turn. The currency's about face is remarkable for a number of reasons. The DXY Dollar Index was at 14-month highs and had just recently clear resistance that represented the 'neckline' on a much larger inverse head-and-shoulders pattern. The progress that remarkable pattern could have represented was significantly undermined by the subsequent four-day retreat (matching the longest series of losses since early January) that moved the market back below the same level that acted as the catalyst in the first place. What has peaked many traders' curiosity is that this retreat has coincided with US President Donald Trump's second unfavorable weigh-in on the local currency. This week, the President repeated his critique of the Fed's hawkish policy and his belief that the Euro and Yuan were being artificially manipulated. This has raised the possibility in many minds that Trump believes the Dollar should be lower than where it currently stands and that he may take steps to achieve exactly that.
The Motivations to Manipulate a Currency
To understand external influence on the FX market, it is first worth evaluating the motivations. What is often overlooked is the reality that there are reasons to raise the currency just as there are to lower it. Typically, the assumption is that all efforts take to influence an exchange rate would be aimed at lowering the local currency in order to bolster the appeal of that country's exports. This is certainly an economic benefit and a frequent acquisition/effort. That said, there are also legitimate and imminently recognizable efforts to prompt the opposite outcome. China provides a good example of why a country would want to lift its currency. While much of the accusations leveled against the country are that it attempts to lower its currency to support trade, there have been times recently when a rapid depreciation of Yuan has raised fears of a possible capital flight of foreign capital from the country. China stepped in ease those concerns. Another current example is Venezuela which has seen its Bolivar collapse from an exchange rate of approximately 10 to over 240,000 against the Dollar in a short period of time. This in turn has prompted hyper-inflation and a financial crisis. They would naturally want to put out the fire.
The Means to Drive a Currency
Now that we understand a few of the key reasons for moving the currency higher or lower, it is necessary to account for the means for which the objective can be achieved. The most common but low impact outlet for this is 'jawboning'. Jawboning is jargon that references an effort to talk a currency high or lower by laying out opinions of value, prioritizing fundamentals or some other insight. These views are given by market authorities whose opinions we would assume can change market assessment. The RBA and RBNZ are just two of the major central banks that employ this strategy regularly - but it has near global employment. Far less common but carrying a distinctly heavier impact on exchange rates is direct intervention by a central bank or finance ministry. The RBNZ has attempted this as well to little effect, but the Japanese Finance Ministry showed dramatic - if not lasting - influence over the Yen particularly around 2011. Finally, there is the more modern but all-consuming mode in monetary policy. The ECB is perhaps the best example as the central bank in 2014 connected an exchange rate (1.4000) to a vow of monetary policy should pressure persist. What resulted was a 3,500 pip drop.
What Options Would President Trump Pursue and Their Effectiveness
Is there a motivation for the US to pursue a change in the level of the Dollar? There is indeed. While the US has generally maintained a 'strong Dollar' policy over decades to secure its position in the global financial system, the rise of trade wars changes the equation somewhat. As President Trump applies tariffs on its largest trade partners (namely China) the appreciation of the Dollar works to diminish the influence of the effort. So what means can he pursue and will they be at all effective? The President has clearly looked for support in lowering the currency via monetary policy, but the Federal Reserve is an institution deliberately set separate from the influence of the rest of the government - and Chair Powell is unlikely to cave to pressure. Direct intervention is a possibility, but it carries questionable legality and the subsequent impact such a move would have given the Dollar's ubiquity would draw severe rebuke from much the world. Jawboning in the meantime is almost certainly to be deployed on a regular basis, though the half-life of its effectiveness has dropped precipitously. There are other, unorthodox means for which Trump could pursue a weaker currency - such as the trade war the US is currently conducting - but full currency cooperation remains intangible. We discuss the United States reasons and means for devaluing the Dollar in today's Quick Take Video.
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