Donald J. Trump has staked his presidency; and his political future on a very interesting, and quite radical economic policy. The policy is a massive expansion of America’s manufacturing sector through a combination of Keynesian stimulus, new monetary policy, protectionism and bullying of businessmen to go along with his policies.
The most interesting item on Trump’s agenda from an investment standpoint is his comment that the “dollar is too strong.” This gives an interesting insight into Trump’s economic thinking and potential policies.
A strong dollar makes U.S. goods uncompetitive on the world market because they will be expensive, which hurts manufacturing and agriculture. A strong dollar also keeps investment out of the United States because investors get “more bang for their buck” elsewhere.
Trump’s hope is that a weak dollar would attract more investment and make U.S. goods more competitive. This policy has worked for some countries notably China, which is now the world’s largest manufacturing country.
Can Trump Really Weaken the Dollar?
The trillion yuan question here, is can Trump really weaken the dollar? Disturbingly nobody knows if such a weakening is really possible.
Bloomberg Finance writer Andrea Wong outlined a few ways that Trump might lower the dollar’s value.
- The first would be talk or rather Trump’s Twitter account. That would not work because traders; the people who really set currency values, don’t listen to government officials. They only pay attention to the price and the market. Trump would actually have to affect exchange rates for Mr. Market to pay attention to him. I don’t see that happening.
- Coordinated intervention. Trump’s Treasury Department would work with foreign central banks to lower the dollar’s value. I don’t see that happening, because a strong dollar benefits some foreign economies – notably China. An even greater stumbling block is economists; who simply don’t like Trump and his ideas. If they do not go along, neither will central bankers – most of whom are economists.
- Unilateral intervention. That would probably require action by the Federal Reserve which seems unlikely until Chairwoman Janet Yellen’s current term ends. It is hard to see what the Treasury could do without the Fed’s help. The Fed; not the Treasury, controls the money supply and interest rates under our current system. Until Trump can appoint his own Fed chair there’s little he can do.
- A Sovereign Wealth Fund. That is a pool of money the government would use to influence the economy. One use for such a fund might to be up foreign currencies in an attempt to increase their value. Another would be to buy bonds or real estate in foreign countries to achieve the same goal. This would require legislation – it is unclear if there is support for such an entity in Congress. It would take quite a while to get legislation through Congress and get the fund up and running. Note: Obama proposed something similar with his plan for a National Infrastructure Bank that would issue bonds to finance spending on projects. Such plans would run into serious opposition from the Fed and conservatives because they would increase government influence over the economy.
- By limiting imports, Trump might limit demand for the dollar and its price. This might backfire by dampening economic activity and killing jobs in the U.S. It might also trigger a trade war – that would kill more American jobs by cutting off markets for U.S. exports.
Would Trump Try Demonetization
There is another dollar weakening strategy that Wong ignores: demonetization. Demonetization is deliberately destroying or limiting the value of currency.
The world leader most like Trump; India’s Prime Minister Narendra Modi, already tried this on November 8, 2016, by arbitrarily declaring the 500 and 1000 rupee notes, his nation’s largest bills worthless. That effectively destroyed the value of 86% of the cash in India, and made the rupee a strong sell on currency exchanges.
Modi justified his actions by citing the use of the 500 and 1000 rupee notes by terrorists and criminals. Trump might try to demonetize the $100 and $50 bills with the justification that they are widely used in the international drug trade. Like Modi, he would try to mask monetary policy with law and order.
Would the president, have the power to take such an action. Currency in the U.S. is issued by the Federal Reserve; which makes a lot of its money selling dollars on the world market. So there would certainly be opposition to a demonetization policy from the Fed.
Another interesting question is would the president have the power to demonetize without Congressional legislation. There is no sign of any support for demonetization in Congress, and a strong possibility of popular opposition. Many people particularly older conservatives; the Republican base, are strongly supportive of paper money and skeptical of electronic currency.
Although it is highly probable that Trump might get support from foreign governments and central banks on $100 demonetization, particularly in China. The People’s Bank of China (PBOC) might welcome U.S. demonetization because it would cut off a channel of currency outflow – the black market purchase of US $100 bills.
What would the Effects of a Weakened Dollar Be?
We now need to ask the question, what would happen if Trump actually weakened the dollar? Some obvious effects would be:
- A weaker dollar would mean more money in circulation which would lead to inflation. The rate of inflation a weak dollar would create is impossible to determine.
- Lower interest rates. The Fed might lower interest rates in an effort to control inflation. This can lead to more economic growth but it might drive more inflation by increasing the money supply further.
- A lower savings rate. One reason why Americans are saving more is the strong dollar. The corporate savings rate is very high, Facebook (NASDAQ: FB) reported $26.14 billion in cash and short-term investments for third quarter 2016, Alphabet (NASDAQ: GOOG) reported $83.06 billion for the same period. Higher inflation and a weak dollar would give companies and governments more incentive to spend. That might drive more inflation.
- More foreign investment in the U.S. because investors would get more bang for their buck.
- Higher stock and real estate prices because investors would have a stronger incentive to buy non-cash investments, particularly those with a high return.
- Depress the bond market because returns on securities would be lowered.
- Average Americans would have less buying power which might dampen economic activity. This might limit the appeal of Trump’s jobs policy by effectively cutting salaries.
- Increased demand for bitcoin and other cryptocurrencies; particularly ethereum. Financially sophisticated Americans seeing a need for a hedge against a weak dollar would buy of these. This would mean higher bitcoin prices. Note a Trump demonetization attempt or proposal would drive bitcoin prices through the roof.
- Increased gold price because many people view gold as an effective hedge. An interesting result might be a boom in the gold coin and jewelry market as average people fearing demonetization rush to cash out.
- Increase the value of other currencies particularly; the Euro, the Pound, the Yen, the Swiss Franc, the Australian Dollar and the Yuan, all of which might be seen as effective alternatives to the dollar.
We need to pay attention to Trump’s weak dollar proposal because it might have catastrophic results. Investors that pay close attention might find themselves in a position to cash in, in a big way.