Wednesday, October 5, 2016

Rubin or Trump as the Strong Dollar Type

Gavyn Davies comes close to making a good point about the Trump policy proposals:
lower taxation and higher defense spending, combined with the abandonment of Bernanke/Yellen-style monetary policy, are fairly mainstream in Republican economic thinking…It is also not that far removed from the policy mix that has been pursued by some previous Republican Presidents, notably Ronald Reagan, George W. Bush and even Richard Nixon. The change in the policy mix under Reaganomics is particularly reminiscent of what might happen under a “respectable” version of Trump’s plan…Another important consequence, which would damage US equities, could be a further rise in the dollar. Under Reaganomics, the dollar started to rise almost immediately after the 1980 elections, and surged for four years until the Plaza Accord in 1985. Despite general dislike among international investors for a President Trump, the probable change in the US policy mix, and the rise in geopolitical risk globally, could cause a large capital inflow into the US.
More on this in a bit but first permit me to express a frustration with an often seen claim that center left types want a strong dollar. I guess this goes back to the suggestion that Robert Rubin pushed a strong dollar in the 1990s. This strikes me as very wrong for reasons that I will note shortly but I will give credit to Tim Duy for this discussion:
The strong Dollar policy takes shape in 1995. At that point, Rubin made it clear that the rest of the world was free to manipulate the value of the US Dollar to pursue their own mercantilist interests. This should have been more obvious at the time given that China was last named a currency manipulator in 1994, but the immensity of that decision was lost as the tech boom engulfed America.
In other words, the U.S. would adhere to freely floating exchange rates even if other nations did not. If one thinks about the Clinton policy mix – fiscal restraint with easy monetary policy – it was the opposite of the Reagan policy mix. To the degree we lowered our interest rates relative to the rest of the world, one would expect ceteris paribus that the dollar would devalue increasing net exports. Of course the dollar appreciated and net exports fell but that was the result of the investment boom which led to a strong increase in real GDP, employment, and even real wages. When progressive critics complain that U.S. macroeconomic policy cost growth and jobs by letting net exports fall, they confuse cause and effect. We might also note this story from early 1997:
Treasury Secretary Robert E. Rubin, taking a little air out of the rapidly rising dollar, suggested today that the Administration had ended its two-year-long effort to drive up the dollar against the world's other major currencies…But it is unclear whether Mr. Rubin and the finance ministers of the other countries will be able to stem the rapid run-up in the dollar's value, a trend that reflects such fundamental forces as a healthy American economy, continued stagnation in Japan and increased nervousness about a unified European currency.
Let’s also remember the history of our exchange rate. The dollar appreciation of the late 1990’s pales in comparison to the dollar appreciation of the first half of the 1980’s. This is what Davies alludes to. Let’s remember that the Reagan policy mix massively appreciated the U.S. dollar which led to a significant fall in net exports. This decline and the crowding-out of investment overwhelmed any aggregate demand benefits from fiscal stimulus leading to a massive recession. Trump’s advisers might argue that he wants to impose tariffs to raise net exports but this Navarro nonsense ignores the prospect that trade protection will only further appreciate the dollar especially if interest rates drift up. In fact, recent financial events where our interest rate have drifted higher than interest rates for many of our major trading partners have drifted up has led to the most recent dollar appreciation and decline in net exports. Center left economists do not advocate a strong dollar or current account deficits but we do understand the interplay between fiscal and monetary policy and how they impact the exchange rate and net exports.

3 comments: said...

PGL, you have one of the larger contradictions of the half-baked econ plan for Trump by Navarro. The only way they are going to manage this elimination of the trade deficit, is if whatever they are doing in terms of protectionism (the likely cudgel), they will need to have that supported by a massive devaluation of the dollar. Not at all clear that Navarro, much less Trump, is smart enough to figure that out. And pulling it off will require an utterly supine Fed.

ProGrowthLiberal said...

Dean Baker says Trump is better on trade than the NYTimes (or CNN):

I did not know CNN pretended to know international macroeconomics. But Dean's discussion regarding China and the US also disappoints:

Actually, China still holds well over $4 trillion in foreign reserves counting the money in its sovereign wealth fund. Given standard rules of thumb, a country with China's level of imports would be expected to hold between $500 billion and $1 trillion in foreign reserves. These additional holds of reserves have the effect of keeping down the value of China's currency, just as Donald Trump claims. (I will not vouch for the fact that this is what Trump is thinking when he complains about currency management.)It is also worth noting that even though China's economy has slowed, it is still growing far faster than the economies in Europe, Japan, and the United States. This would be expected to lead to an inflow of capital to China, which would correspond to China running a trade deficit. Instead, China is continuing to run a trade surplus of between 2–3 percent of GDP.

Dean has his standard rules of thumb but it is not clear where he get these notions. Dean also talks about capital flows in a pure multiplier model that ignores monetary policy and interest rates. Currently the interest rate on Chinese 10-year government bonds is higher than our interest rates but the interest rates in Europe are lower. Maybe this is why the Euro has devalued with respect to the US dollar as well as with respect to the Chinese currency. Our recent decline in net exports is more from what is happening with the Euro than China.

Random said...


The key point is that if a currency moves down so that imports become 'more expensive', then the 'inflation' that goes off is a distributional response that tries to eliminate some of those imports so that the exchange demands equalise. That also eliminates somebody else's exports.

The important thing to remember is that when a currency goes down, all the others in the world go up in relation to it and nations that rely upon exports (export led nations) start to lose trade - which depresses their own economy.

Any one of those other economies can intervene in the foreign exchange markets, purchase the 'spare' currency and that will halt the slide for everybody. And all exporters to an import nation have a central bank with infinite capacity to do that.