The surge in the US dollar in the ten days since the election to decade-long highs underlines a seeming contradiction in President-elect Donald Trump's approach to restoring US international competitiveness. An important part of his strategy to achieve that goal has been his insistence on renegotiating trade deals to US advantage and on cracking down on countries that manipulate their currencies. Yet at the same time, Mr. Trump seems bent on a highly expansionary fiscal policy that if implemented risks propelling the US dollar ever higher, which would almost certainly undermine US competitiveness across the board.
The 3% jump in the US dollar and the large bond selloff since Mr. Trump's election last week should have come as no surprise. After all, his election very much heightens the chances that US taxes will be slashed and that public spending on infrastructure and defense will be substantially increased.
With the economy currently at close to full employment, such a shift to a very much more expansionary US fiscal policy risks stoking inflation and provoking a more aggressive monetary policy tightening from the Federal Reserve than would otherwise have been the case. That in turn risks increasing the degree to which US monetary policy and that in Europe and Japan would become out of sync, which would tend to keep the US dollar on a steadily rising path.
A very much stronger US dollar would seem to be the last thing that a fragile global economy now needs for at least two reasons. The first is that it would give impetus to Mr. Trump's calls for renegotiating trade deals and toughening up on currency manipulators. This would especially be the case if China, along with the rest of the world, continued to allow its currency to depreciate against the US dollar. That in turn would raise the risk of trade retaliation by US trade partners that could lead us down the road to escalating trade protection and currency wars.
The second reason to fear a strong US dollar is that it would put inordinate strain on a number of major emerging market countries. As the Bank for International Settlements keeps reminding us, emerging market corporates have managed to increase their US dollar denominated borrowing by around US $ 3.5 trillion over the past eight years. Should emerging market currencies keep plunging against the US dollar, their corporate sectors could have great difficulties in servicing those loans.
Hopefully, Congress will temper Mr. Trump's fiscal stimulus proposals and insist on a more disciplined fiscal policy approach that might be more consistent with a stable rather than a rising US dollar. However, given politicians' predilection for tax cuts and public spending increases, I am not holding my breath for that to happen and fully expect the US dollar to continue its upward march.