Category: Currencies

A month into the second coming of Donald Trump, the world is grappling with the meaning of his obsession with trade tariffs. Though it is highly unclear what the details of trade policy will be, it appears the primary objective may be to force global firms to reshore manufacturing to the United States. Policymakers, such as Treasury Secretary Scott Bessent, are talking about a “great economic restructuring,” leading analysts to speculate on possible international agreements to secure investments and bring down the value of the dollar, as was successfully achieved during the Reagan Administration in the 1980s.

The strength of the U.S. dollar is a problem for a government determined to bring back the mercantilist policies of the late 19th century in America. As the chart below shows, the Real Effective Exchange Rate (REER) for the USD is at an extraordinarily high level, well beyond previous peaks in 1960, 1970, 1984, and 2002.

Periods of dollar weakness are associated with strong international growth relative to U.S. growth and a spell of “American malaise,” while periods of dollar strength are linked to stronger U.S. growth and phases of “American exceptionalism.” The dollar has been appreciating since early 2011 in a remarkable occurrence of American exceptionalism, driven by a relatively strong recovery from the Great Financial Crisis, the shale oil and gas revolution, and the phenomenal success of America’s tech titans. Over the past decade, the dollar has also been buttressed by enormous capital flows into U.S. assets, which originate both from institutional investors seeking high returns and from capital flight from emerging markets.

It is unclear how dollar weakness could be engineered by the Trump Administration, as “America First” strategies would tend to favor U.S. growth at the expense of foreign partners and could lead to large investment inflows. Moreover, the chaos created by Trump’s disruptive nature may increase geopolitical risk and further encourage capital flight into U.S. assets.

We can speculate on which countries may be targeted by Trump for retributive attacks. The chart below shows the REERs of America’s main trading partners and emerging markets in terms of the current REER relative to the median of the past 32 years. Japan stands out as an outlier and as an easy target for forced currency appreciation. Europe, Mexico, and the Asian tigers (Korea, Taiwan, and Malaysia) also could be singled out. The circumstances of most emerging markets (Chile, Brazil, Nigeria, etc.) are very different, as currency weakness is not engineered to sustain export competitiveness but rather caused by low growth and capital flight.