Originally published at Project-Syndicate | Jan 10th, 2024
US President-elect Donald Trump’s incoming administration will likely seek to weaken the greenback’s exchange rate. But whether doing so would enhance the competitiveness of US exports and strengthen America’s trade balance is another matter.
BERKELEY – One of the more jaw-dropping policy ideas gaining political steam in the United States recently has President-elect Donald Trump and his team, on taking office, actively depressing the dollar with the goal of boosting US export competitiveness and reining in the trade deficit. If Trump tries, will he succeed? And what could – and probably would – go wrong?
On the question of whether Trump could weaken the dollar, the answer is clearly yes. But whether doing so would enhance the competitiveness of US exports and strengthen America’s trade balance is another matter.
The brute-force method of pushing down the dollar would entail leaning on the Federal Reserve to loosen monetary policy. Trump could replace Fed Chair Jerome Powell and push Congress to amend the Federal Reserve Act to compel the central bank to take marching orders from the executive branch. The dollar exchange rate would weaken dramatically, which is presumably the point.
But the Fed would not go quietly. Monetary policy is made by the Federal Open Market Committee’s 12 members, not just by the chair. Financial markets, and even a lapdog Congress, would see abrogating the Fed’s independence or packing the FOMC with compliant members as a bridge too far.
And even if Trump succeeded in “taming” the Fed, a looser monetary policy would cause inflation to accelerate, neutralizing the impact of the weaker dollar exchange rate. There would be no improvement in US competitiveness or the trade balance.
Alternatively, the Treasury Department could use the International Emergency Economic Powers Act to tax foreign official holders of Treasury securities, withholding a portion of their interest payments. This would make it less attractive for central banks to accumulate dollar reserves, driving down demand for the greenback. The policy could be universal, or US friends and allies, and countries that obediently limit their further accumulation of dollar reserves, might be exempt.
The problem with this approach to weakening the dollar is that by driving down demand for US Treasuries, it would drive up US interest rates. This radical step might reduce demand for Treasuries quite dramatically indeed. Foreign investors could be led not merely to slow their accumulation of dollars but to liquidate their existing holdings entirely. And while Trump could attempt to deter governments and central banks from liquidating their dollar reserves by threatening tariffs, a substantial share of US government debt held abroad – on the order of one-third – is held by private investors, who are not easily swayed by tariffs.
More conventionally, the Treasury could use dollars in its Exchange Stabilization Fund to buy foreign currencies. But increasing the supply of dollars in this way would be inflationary. The Fed would respond by draining those same dollars from the markets, sterilizing the impact of the Treasury’s action on the money supply.
Experience has shown that “sterilized intervention,” as this combined Treasury-Fed operation is known, has very limited effects. Those effects become pronounced only when the intervention signals a change in monetary policy, in this case in a more expansionary direction. Given its fidelity to its 2% inflation target, the Fed would have no reason to turn in a more expansionary direction – assuming its continued independence, that is.
Finally, there is talk of a Mar-a-Lago Accord, an agreement by the US, the eurozone, and China, echoing the historic Plaza Accord, to engage in coordinated policy adjustments to weaken the dollar. Complementing steps taken by the Fed, the European Central Bank, and the People’s Bank of China would raise interest rates. Or China and Europe’s governments could intervene in the foreign exchange market, selling dollars to strengthen their respective currencies. Trump could invoke tariffs as a lever, much as Richard Nixon used an import surcharge to compel other countries to revalue their currencies against the dollar in 1971, or as Treasury Secretary James Baker invoked the threat of US protectionism to seal the Plaza Accord in 1985.
In 1971, however, growth in Europe and Japan was strong, so their revaluing was not a problem. In 1985, inflation, not deflation, was the real and present danger, predisposing Europe and Japan toward monetary tightening. In contrast, the eurozone and China currently confront the dual specters of stagnation and deflation. They would have to weigh the danger to their economies from monetary tightening against the damage from Trump’s tariffs.
Faced with this dilemma, Europe would probably give in, accepting a tighter monetary policy as the price for rolling back Trump’s tariffs and preserving security cooperation with the US. China, which sees the US as a geopolitical rival and seeks to decouple, would probably take the opposite course.
Thus, a supposed Mar-a-Lago Accord would degenerate into a bilateral US-European agreement that did the US little good while inflicting considerable harm on Europe.
Barry Eichengreen: Professor of Economics and Political Science at the University of California, Berkeley, is a former senior policy adviser at the International Monetary Fund. He is the author of many books, including In Defense of Public Debt (Oxford University Press, 2021).