Daily Comment (January 18, 2017)

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EST] President-elect Trump caused a stir yesterday when he suggested that he doesn’t want a strong dollar.  Some of the commentary we saw suggested that this is nearly “unprecedented.”  That’s not really the case.  Since the dollar began floating under Nixon, presidents have, on occasion, discussed the dollar or had key cabinet members, normally the treasury secretary, try to “jawbone” the dollar.  Nixon was comfortable with dollar weakness.  His treasury secretary, John Connally, told European leaders soon after the collapse of Bretton Woods that the dollar is “our currency but it’s your problem.”  President Reagan initially cheered the stronger dollar as he saw it as confirmation of his policies and he wanted to contain inflation.  However, by his second term, he became concerned about the dollar’s impact on manufacturing so he had his treasury secretary, Jim Baker, organize the Plaza Accord, which was a joint effort by the G-5 to weaken the dollar.  In 1987, after the dollar had declined, Baker, angry at Germany over its policies, threatened to push the dollar lower.  Some have suggested this was a contributing factor to the 1987 Stock Market Crash.  President Clinton’s first treasury secretary, Lloyd Bentsen, openly called for a stronger yen.

The “modern” policy on the dollar was developed by Clinton’s second treasury secretary, Bob Rubin.  Rubin simply said that the U.S. should always support a “strong dollar,” irrespective of how it is actually trading, and at the same time let markets set the exchange rate.  This policy really had no content in terms of the level of the exchange rate.  What it did do was take the exchange rate out of policy discussion and end the practice of using oral intervention to move exchange rates.  Early in President George W. Bush’s administration, his treasury secretary, Paul O’Neil, suggested the dollar was too strong.  The currency plunged and he was forced to backtrack into the Rubin policy, suggesting that if U.S. currency policy changed, he would “rent out Yankee Stadium” to let everyone know.

Since O’Neil’s comment, every subsequent treasury secretary has fallen back on the Rubin dollar policy.  Trump’s comments could be signaling that the Rubin policy may be coming to a close.  If the incoming president decides to start commenting on the level of the dollar, instead of making innocuous comments about the “strong dollar,” it will lead to much higher exchange rate volatility.  It may encourage other nations to make similar comments.  The benefit of Rubin’s policy was that it toned down the rhetoric in the currency markets.  If the policy is being jettisoned, volatility will tend to rise.

At the same time, it is important to note that Trump’s policies appear to be quite bullish.  Tariffs implemented by the reserve currency nation tend to strengthen its currency because it reduces the supply available on world markets.  If the border adjustments are part of corporate tax reform, that is dollar bullish.  If tax reform encourages repatriation of corporate liquidity held overseas, that is dollar bullish.  And, if infrastructure spending and tax cuts boost the economy, it will likely lead to tighter monetary policy (this may be the most interesting issue to watch this year) and, again, a stronger dollar.  Simply put, Trump may try to talk the dollar down but his policies will tend to move the dollar in the opposite direction.

View the complete PDF