Trump, a currency manipulator?

Observers claim he will launch campaign to weaken the dollar to reduce trade deficit

NEW YORK: The United States, a currency manipulator?

It’s a label more frequently slapped on developing export economies and one that President Donald Trump took up just this week to browbeat China and Europe in his increasingly pitched trade war.

But as outlandish as it sounds, some Wall Street observers say the possibility that Trump himself will launch a sustained campaign to weaken the dollar as a way to reduce the US trade deficit can’t be dismissed.

“The trade debate will increasingly include the currency issues,” said Charles Dallara, a former US Treasury official and one of the architects of the Plaza Accord, the 1985 watershed agreement between the United States and four other countries to jointly depreciate the dollar. “It’s inevitable.”

Granted, Dallara didn’t specifically use the word manipulation. There’s something of a reluctance among analysts to associate the United States, the standard-bearer for free-market principles, with the term. They prefer to refer to it as foreign-exchange intervention. Semantics aside, a shift to a more protectionist and interventionist policy, ala 1985, would not only reverberate across the US$5.1 trillion-a-day currency market and undermine the dollar’s status as the world’s reserve currency, but could also weaken demand for US assets.

Since falling toward a three-year low in April, the dollar has appreciated almost 6%, according to the Bloomberg Dollar Spot Index. Its advance last quarter was the strongest since 2016, as the greenback appreciated against all 16 major currencies. The dollar is also 11% above its average over the 13-year span of the dollar index.

A strong-dollar policy has been a cornerstone for successive US administrations. The United States was also a key supporter of the July Group-of-20 pact that member economies will “refrain from competitive devaluations, and will not target our exchange rates for competitive purposes.”

Yet like many other things, Trump has shown a penchant for upending the status quo. Since taking office in 2017, he has routinely talked about wanting a weaker dollar to support US manufacturing. His administration has arguably been, at best, lukewarm toward America’s traditional strong-dollar stance.

After a flurry of tweets in which Trump complained that the dollar is blunting America’s “competitive edge,” Michael Feroli, JPMorgan Chase’s chief US economist, wrote in a report this month that he can’t rule out the possibility the administration will intervene in the currency markets to weaken the greenback. Both Deutsche Bank and OppenheimerFunds echoed the view, saying dollar intervention was no longer far-fetched.

Deliberate effort

“We haven’t had a deliberate effort to weaken the US dollar perhaps since the Plaza Accord in 1985, so it is very unusual and against established practice over the last several decades,” said Zach Pandl, co-head of global FX strategy at Goldman Sachs.

“A deliberate policy to pursue a weaker currency could cause foreign investors to shy away from US assets – including Treasury bonds – raising interest costs for domestic borrowers.”

There are some signs that Trump’s persistent jawboning of the dollar may already be having an adverse effect on foreign demand for US assets. While overall demand at auction has been up and down this year, foreign holdings of Treasuries have slumped to an almost 15-year low of 41%. China, the largest overseas creditor, has pulled back this year. Japan, the second biggest, has reduced its share to the lowest level since at least 2000.

Not thrilled

In recent months, Trump has stepped up the rhetoric as the dollar has bounced off its lows. In an interview published by Reuters this week, Trump once again accused China and the European Union of manipulating their currencies.

Last Friday, he also complained to wealthy Republican donors that he was “not thrilled” with the Federal Reserve’s interest-rate increases under chairman Jerome Powell, which have boosted the dollar.

So what tools does Trump have at his disposal if he wanted to go beyond mere talk? The most direct would be for him to order the US Treasury (via the New York Fed) to sell dollars and buy currencies like the yen and euro using its Exchange Stabilisation Fund, according to Viraj Patel, an FX strategist at ING. But because the fund only holds US$22bil of dollar assets, the impact would likely be minimal. Any direct intervention that is larger and more ambitious in scope would also require congressional approval, he said.

However, Patel says there is one loophole Trump could exploit to get around the fund’s constraints and bypass Congress altogether: by declaring FX intervention a “national emergency.” By doing so, he could then force the Fed to use its own account to sell dollars. Such a move would be a long shot by any stretch of the imagination, but with Trump invoking national security to impose tariffs, Patel says he can’t “completely rule out” the possibility.

FX clauses

A less extreme, and more plausible, option would be for the Trump administration to include currency clauses in any new trade deals, like it did with the updated US-South Korea trade agreement in March.

There are plenty of caveats, of course, and the odds of any kind of US intervention are still low. At the G-20 summit, Treasury Secretary Steven Mnuchin assured fellow finance ministers the United States wouldn’t meddle in foreign-exchange markets. And while White House trade adviser Peter Navarro has broached the subject of a global accord on currencies in the past, the chances of a multilateral agreement on the dollar are remote.

Plus, there’s always the threat of retaliation by other nations if the United States goes it alone.

Nevertheless, many who recall the events in the early 1980s that culminated in the Plaza Accord see certain parallels to what’s happening today.

Then, as now, the dollar’s strength on the back of rising interest rates was at the centre of trade tensions between the United States and other major economies. Protectionism was on the rise, as were fears of foreign imports costing American jobs. Then, the bogeyman was Japan. Today, it’s China.

Precipitous drop

And as the trade war with China intensifies, some are worried the yuan’s precipitous drop may prompt the US to open a new front in the FX markets. The yuan has tumbled 9% since April, when trade friction with China started to intensify. The magnitude of the decline, by some measures the fastest since the 1994 devaluation, boosted speculation the People’s Bank of China (PBoC) is deliberately weakening the yuan to offset the tariff impact.

There are reasons to think that China isn’t trying to weaponise the yuan. A senior official at the PBoC said this week that China won’t use competitive currency devaluation as a tool to cope with trade tensions. Earlier this month, the central bank effectively made it more expensive to short the currency as it sought yuan stability.

That hasn’t stopped Trump from criticising the country for taking advantage of the United States by keeping its exchange rate artificially low. (It’s worth noting that the Treasury Department, which conducts a twice-yearly review of international foreign-exchange policies, declined in April to formally name China a currency manipulator based on its own set of criteria.)

The trade debate will increasingly include the currency issues. Charles Dallara

Playing games

Eurizon SLJ Capital’s Stephen Jen warns that Trump may be quick to retaliate in the FX markets if it suspects that China is “playing games with its currency,” which may have disastrous effects on demand for US assets.

“If you’re an international portfolio manager with 30% of your exposure to the United States, and you know the currency will be guided meaningfully lower as a policy tool, why would you be investing here?” he said. “The Trump administration needs to be very, very careful with its dollar policy.”

Recall how the Fed’s quantitative easing sowed frustrations in emerging markets over what some officials saw as a means to manufacture a weaker dollar. Guido Mantega, Brazil’s finance minister at the time, went as far as to say the Fed was throwing money “from a helicopter” and “melting” the dollar.

Whatever the case, Dallara is bracing for more turbulent times.

“I’ve lived through a lot of market gyrations in my career,” he said. “And I have an uneasy feeling that I can’t validate by data that tensions are going to, at some point, emerge into volatile market dynamics. This is a risk.” — Bloomberg