Here Are At Least A Half-Dozen Ways A Currency War Could Go Wrong For The US

You can count Deutsche Bank among those who are skeptical about the case for active, outright FX intervention on the part of the Trump administration. And by that, we mean Deutsche doesn’t sound convinced that it’s advisable or that it would work.

The prospect of Steve Mnuchin wading into the market no longer seems far-fetched in light of the president’s incessant references to currency “manipulation” on the part of Europe and China, who Trump insists are “playing games” with him.

To be sure, there is a sense in which Trump is right. “I believe one of the only ways that QE actually works successfully is to indirectly drive down the currency”, SocGen’s Albert Edwards wrote last week. “Of course, you are not directly targeting it, but you know as night follows day exactly what is going to happen”.

We’ve made similar remarks in these pages. Competitive easing, trade wars and currency wars are inherently related and, in many respects, synonymous, so whether explicit or implicit, overt or tacit, this is a discussion we’ve all been having since Trump became president.

Trump is seemingly at wit’s end with the resilient greenback and, unwilling to concede that part of the “problem” (and the scare quotes are there for a reason) is down to his administration running a policy mix that’s conducive to dollar strength on multiple fronts, his options for “correcting” the situation are limited to badgering the Fed for rate cuts and, failing that, overt intervention.

The problem with the former is that as long as the rest of the world is easing, Fed cuts might not be sufficient to catalyze significant dollar weakness – that’s especially true if the US economy continues to hold up well relative to the rest of the world.

The problems with the latter (i.e., the problems with intervention) are myriad.

“That a Trump inspired intervention would go against most of his advisers suggests there is much less chance of official USD sales occurring while more prominent measures of economic success, like equities, are buoyant”, Deutsche’s Alan Ruskin writes, in a new note. He also reminds you that timing matters. There’s a lag between dollar weakness and any positive impact on growth, which means the window for intervention is probably small considering the proximity of the election.

“Weakening the USD now could work with the 2020 election timetable, while weakening the USD next year, would likely generate growth/inflation implications that are more negative than positive”, Ruskin says, adding that “even by early 2020, the President’s team of advisers will encourage the President to highlight how the strong (‘King’) USD is a sign of a strong US economy”.

But that’s hardly the only issue. Ruskin also notes that while the Fed would probably go along with Mnuchin, the intervention would be sterilized to avoid even the perception that Trump has essentially found a backdoor to co-opting monetary policy. “Another very strong reason for Fed FX sterilization, would be if Treasury inspired FX intervention is perceived to be motivated by domestic politics, and is a way in which Administration is seen trying to take hold of a monetary lever, usurping the Federal Reserve’s independence”, Deutsche goes on to say.

Beyond that, Ruskin doesn’t necessarily see the valuation case either. “Our latest valuation metrics put the USD 10% expensive on a PPP basis, but more sophisticated measures like FEER shows the USD cheap by 4%, in part because the extraordinary improvement in the US petroleum balance has left the Current Account unusually stable in this US upswing”, he writes, before delivering an assessment of who’s to “blame” that is largely consistent with everything we’ve said previously about the extent to which it is the administration’s own policy mix that’s perpetuating the current situation where the greenback couldn’t roll over even if it wanted to.

Here is Ruskin to explain things far more succinctly than we have, considering our love affair with verbosity:

Beyond valuation, another reason the US will struggle to gain any international support to push against USD strength, is that much of the USD’s strength is a result of a policy mix instigated by the US Administration, where an unprecedented late cycle fiscal stimulus, has fueled the tighter monetary policy response. That the larger public sector deficit has not as yet resulted in a large external deficit suggests there has been some immediate Ricardian equivalence at work whereby an increased private sector surplus has offset the public sector deficit. In any event, fiscal stimulus initially helps but then usually hurts a currency because of legacy debt and deficits. We are only just entering the phase where it should start to hurt the USD.

That suggests it’s going to be a while before America’s deteriorating fiscal predicament precipitates any dollar weakness.

In addition to all of that, Trump’s aggressive rhetoric towards, for instance, Mario Draghi, is akin to insisting that other countries aren’t allowed to pursue their own monetary policies. That would be presumptuous enough in normal times, but it’s downright offensive when part of the rationale for the easing you’re seeing in other locales is that the Trump administration’s trade wars are imperiling the outlook for growth. As we’ve put it previously, Trump is waging economic war on allies and foes alike and then demanding (on Twitter no less) that those countries’ central banks do not take steps to defend their respective economies.

Ruskin underscores this as well. “Trying to curtail central banks from pursuing easy policy because this leads to some FX impact, is tantamount to trying to take away monetary independence from central banks and almost all monetary authorities, inclusive of the Fed will see this as a red line”, he warns.

Further, Deutsche notes that there’s more than a little irony in the US being potentially on the verge of undermining decorum when it comes to FX intervention.

“There are no obvious alternatives to the G20 FX intervention rules the US has in past pushed for so strongly [and] the US-inspired system survives only as long as the US does not intervene with any persistence”, the bank says. The implication is that if Trump does start intervening (and especially if he does so with any persistence and/or regularity) all bets will be off. Other nations will unilaterally intervene and may well even band together against the US, on the assumption that nobody is playing by the rules anymore.

Ultimately, Ruskin says intervention isn’t likely to work anyway, for five reasons. First, there’s not a compelling story to tell about a fundamentally overvalued greenback. Second, the surprise factor is clearly off the table at this point. Third, everybody knows which way Trump wants this to go (i.e., a weaker dollar) which waters down the already non-existent element of surprise. Fourth, Mnuchin would be going it alone, as other countries aren’t going to participate and might well push back in the other direction. Fifth, the Fed would sterilize any intervention.

Deutsche then runs through a variety of “unintended consequences”, including the idea that if intervention proves ineffective, Trump would likely become even more frustrated, raising the odds of further tariffs and other trade escalations. But perhaps the most foreboding (if unlikely to materialize) issue is this, from the note:

Last but by no means least, intervention undermines the USD’s longer-term reserve currency status. Trade wars, and, the use of the USD’s preeminence within global transactions to enforce sanctions, are some of the political factors chipping away at the USD’s role as a reserve currency. This is being masked by the USD’s relatively high interest rates, and therefore more likely to be in evidence as the USD’s rate advantage erodes.

We’ll just leave it at that.


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