US(D) policy on the wrong track

The United States Secretary of the Treasury, Steven Mnuchin, was the cause of significant market turbulence on Wednesday, following his claim that a “weaker dollar” would be a positive sign for the U.S. export sector. It was not necessarily the content of his statement itself which surprised the markets (it is an incontestable fact, after all, that weaker currencies tend to promote exports), but rather the fact that a high-ranking member of the U.S. government would even comment on the external value of the U.S. dollar. The market reacted quickly and despite the U.S. dollar appearing to be in better shape again today, there remains huge uncertainty surrounding the Trump administration’s official policy on the greenback.

It is not the first time that the strong dollar policy has been thrown into doubt. Robert Rubin, former United States Secretary of the Treasury under the Clinton administration, first introduced the policy in 1995, which was subsequently carried on by all his successors, albeit not always with quite the same level of conviction. In actual fact, the U.S. government’s attitude to the U.S. dollar can currently be best described as “ambivalent”. While every government over the past 20 years has stuck rigidly to the strong dollar mantra, worries about the negative economic effects of the dollar being too strong were never far away. And certainly there tended to be good reason for this. However, a weaker dollar also harbours significant dangers, not only with regard to the U.S. budget deficit but also with regard to the fact that the U.S. dollar is the world’s major reserve currency, a status it has enjoyed since the end of the Second World War when the Bretton Woods agreement was signed in 1945. In terms of volume and liquidity, no other market can compete with the U.S. sovereign bond market, making it particularly attractive to reserve managers. In many respects, the dollar’s status as the world’s largest reserve currency is certainly a blessing, as it allows the USA almost unlimited access to international capital. However, for the U.S. dollar, with great reserve status comes great responsibility.

Not only in fiscal policy terms, but also with regard to the external value of the dollar. This was surely also a reason for introducing the strong dollar policy under Rubin. After all, even if the U.S. government has never had to take active steps to support the dollar, the strong dollar policy always represented something of a guarantee that the government would never aim to devalue its domestic currency. We do not believe that Steven Mnuchin’s comments in Davos should be interpreted as a sign that the U.S. government has fundamentally changed tack with regard to the strong dollar policy. However, the strong market reaction reveals that investors would essentially not put anything past the Trump administration. However, even for the populist Donald Trump, a termination of the strong dollar policy that has been a mainstay of the last 20 years would appear to be too risky.

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