What Exactly Does Trump Want for the Dollar?

(Bloomberg Businessweek) -- Since the 1990s the U.S. has explicitly stated that a strong dollar is in the nation's best interest. Global investors have come to take this stance for granted, giving them confidence that American officials won't debase the greenback.

But the Trump administration's chaotic messaging is shaking up these assumptions. A strong dollar is “a beautiful thing in one way, but it makes it harder to compete,” President Trump said on July 26, adding that he hasn't ruled out taking action to weaken the U.S. currency. His comments contradicted those of White House economic adviser Larry Kudlow, who just hours earlier said the U.S. wouldn't intervene in currency markets.

The public back-and-forth intensified questions about America's currency policy. The strong-dollar dogma was introduced by then-Treasury Secretary Robert Rubin in 1995 as a way to bolster foreign demand for U.S. Treasuries, and it helped cement the dollar's long-standing status as the world's reserve currency of choice. The pledge to not devalue the greenback encourages international investors and U.S. trading partners to park their cash in U.S. assets.

A weaker dollar would offer some benefits. U.S. manufacturers would get a leg up in selling their products abroad—their wares would become cheaper for foreign customers. At the same time, American companies and people buying imports would see prices rise. Abandoning the policy would also have implications for global markets and, in the long run, for U.S. government finances. Foreigners' faith in the dollar makes them more willing to hold U.S. debt, bringing down the interest rates the Treasury Department must pay.

At the moment, attracting global money isn't a problem: Foreign holdings of Treasuries were at a record high of about $6.5 trillion in May. Investors have few alternatives in a world where many bonds in Europe and Japan actually pay negative yields, compared with about 2% for 10-year Treasuries. But Trump's push for a weaker dollar could begin to crimp that inflow of international money, says Catherine Mann, Citigroup Inc.'s global chief economist.

In the eyes of Brad Setser, a former deputy assistant secretary for international economic analysis at the Treasury, the strong-dollar policy ended as soon as Trump began complaining about the greenback's strength. While past administrations left commenting on currency policy to the Treasury, Trump broke from tradition early. Before even taking office, he said in early 2017 that a strong dollar was “killing us.” In the years since, he's taken to Twitter to bemoan the dollar's strength and to take aim at Europe and China for what he sees as currency manipulation.

“Given the thrust of communication over the past two years, I continue to believe that the era of the strong-dollar policy is over,” says Nathan Sheets, chief economist for PGIM Fixed Income and a former Treasury official. “This is something different. What's not yet clear is exactly how to characterize the new dollar policy and the features of the new regime.” Even so, Trump's desire for a weaker currency should be taken seriously by markets, says Setser, now a senior fellow at the Council on Foreign Relations.

Treasury Secretary Steven Mnuchin has sent mixed signals on the dollar, which has gained against most of its Group of 10 peers in 2019. A trade-weighted index of the greenback adjusted for inflation isn't far below its highest point since 2003, showing the headwinds U.S. exports face. “Over the long term, I do believe in a strong dollar, which signifies a strong U.S. economy,” Mnuchin told CNBC on July 24, adding that he wouldn't push for a “weak-dollar policy” in the near term. That assertion came days after he told Bloomberg News that there's no change in the nation's currency policy “as of now”—a disclaimer that stoked speculation that the U.S. could later step into markets to forcibly weaken the dollar.

Wall Street analysts still see intervention as an outside chance but not impossible. The U.S. hasn't sold dollars for the purpose of weakening the currency since 2000, a move that was part of a coordinated international effort to buoy the euro. Unilateral intervention would torpedo a long-standing commitment reaffirmed in June by the U.S., along with other Group of 20 members, to avoid weakening exchange rates to boost exports. The events of late July suggest there are divisions within the administration over whether to take that step.

A simpler way for Trump to get a weaker currency would be to say that the U.S. is scrapping its policy, Bank of America Corp. strategists wrote in a report in July. Although the phrase “strong-dollar policy” is largely symbolic, abandoning it in favor of a “strong-growth policy” would ripple through the markets and could spur a 5% to 10% drop in the greenback, they estimated. However, the administration would need to be careful to communicate the pivot in a way that doesn't “undermine the case for owning U.S. assets,” the analysts cautioned.

Replacing this Clinton administration legacy would create lots of unknowns. What matters, Setser says, is “not so much the death of the strong-dollar policy, so much as what policy options that might open.” —With Saleha Mohsin

To contact the editor responsible for this story: Pat Regnier at pregnier3@bloomberg.net, Mark Tannenbaum

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