President Trump, please smash the dollar
Trump might back down from weakening the dollar. Big mistake.
For roughly two decades, American policymaking has devoted itself to a strong dollar.
That means the federal government seeks to keep the U.S. dollar more valuable than other countries' currencies on the international markets. The practice began in the Clinton administration, and ran through the Bush and Obama White Houses. So observers kind of wigged out in January when President Trump said the dollar is "too strong," suggesting his administration might break with his predecessors.
Since then, Treasury Secretary Steven Mnuchin has clearly tried to walk things back. "When the president-elect made a comment on the U.S. currency, it wasn't meant to be a long-term comment," he explained at the time. This week, Mnuchin repeated the mantra: "A lot of the appreciation of the dollar [i.e. its rise in value relative to other currencies] since the election in particular is a sign of confidence in the Trump administration and the economic outlook for the next four years."
That's all unfortunate, because Trump originally had the right idea.
Here's the deal. Mnuchin isn't wrong that a strong dollar is a vote of confidence by investors in America. When a national economy is going strong — or at least stronger than everyone else's economies — more investors want to pour their money into assets denominated in that country's currency. Demand for the currency increases, so its relative value goes up.
The problem is that saying you want a strong dollar because you want a strong economy is sort of like saying you want slim cut shirts because you want to lose weight. It gets the cause and effect entirely backwards. Moreover, the purpose of letting your currency change in value in response to international supply and demand is to keep your economy on an even keel. In a bad economy, the relative value of your currency falls, which makes your exports cheaper, which helps you recover. If your economy is running too hot, a super-strong currency will make your exports more expensive and cool you off.
The strength or weakness of the dollar thus serves as a natural corrective. A "strong" dollar may sound good, but in truth it's entirely relative to circumstances. If you try to dictate the strength of the dollar, you undermine that corrective function and produce all sorts of perverse side effects.
For instance, it was Robert Rubin, Bill Clinton's treasury secretary from 1995 to 1999, who first announced the government's commitment to a strong dollar. His goal was to keep inflation in check, since a more valuable dollar correlates with higher interest rates. But again, this gets the causal relationship backwards: A strong economy will naturally drive up interest rates, thus checking inflation, for the same reason it will naturally drive up the dollar.
Rubin's opportunity came with the East Asian financial crisis. Using the leverage of the Treasury Department and the International Monetary Fund, Rubin helped engineer a resolution to the crisis where the indebted countries paid back their creditors in dollars. This helped solidify the dollar's international role as the globe's reserve currency, used by other countries to settle international financial transactions and stockpile for a rainy day.
As a result, we lost manufacturing jobs, working-class wages stagnated, and inequality rose — all of which helped along the political and economic forces now upending American politics. The flows of capital that naturally result from a trade deficit also helped destabilize our economy and inflate the financial bubble that popped in 2008.
Could Mnuchin and the Trump administration do something about this?
Well, as Rubin demonstrated, America's geopolitical clout gives it enormous influence over international finance. If Rubin could use that power to drive up the dollar, it stands to reason that Mnuchin could use it to do the opposite. In fact, during the Reagan administration, after the Federal Reserve's sky-high interest rates strengthened the dollar, Treasury Secretary James Baker met with our international allies to negotiate a sell-off of reserves to bring it back down. And it worked: Over the latter half of the 1980s, the dollar weakened and the trade deficit closed completely.
The real question is whether the dollar's status as the global reserve currency is so solidified now that nothing can overturn it. If that's the case, the answer is more federal deficit spending: That will counterbalance the trade deficit's drag on job creation and create lots of safe assets (i.e. U.S. treasury securities) for people to sock their dollars away in.
This is another irony: Fans of a strong dollar also tend to be fans of balanced budgets. But the circumstances created by a strong dollar actually necessitate bigger deficits.
So, all things considered, the strong dollar policy was a bad call. And if you parse Mnuchin's recent comments, he clearly understands this: He keeps dropping diplomatic caveats about how "an excessively strong dollar may have negative short-term implications on the economy." But he also clearly feels the gravitational pull of America's historic strong dollar policy.
If the Trump administration wants to repair this mess, they'll need the courage to overturn some shibboleths along the way.