September 20, 2019

We believe that President Trump is not wrong when he argues that other economies are manipulating their currencies in order to improve their trade balance. The question is whether that is an effective policy initiative. Economies with a deteriorating exchange rate are experiencing a capital outflow, an improving trade balance and a deteriorating term of trade are slowing down relative to the US economy, as a result they will not tend to create wealth as fast as the US. Monetary attempts to manipulate the exchange rate only result in changes in the trading partners inflation rate differential without impacting the terms of trade and or a country’s trade balance. Figures 5 to 7 offers a more compelling interpretation of the data. If our interpretation is correcting, attempt to jawbone the Fed into reacting to the strengthening dollar would take the Fed off its game, delivering price stability. The downside of President Trump’s views regarding interest rates and the dollar, i.e. advocating lower interest rates and a weaker dollar, could also affect the conduct of fiscal policy. The administration could try to attempt to correct, the perceived Fed weaknesses through fiscal policy action, i.e. tariff increases in order to presumably offset the dollar appreciation and the deterioration of the trade balance. These polices would in turn further slowdown the pace of economic activity.

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